(Bloomberg) — Bank of England Governor Andrew Bailey signaled a major shift in the central bank’s strategy for removing emergency stimulus, stressing the need to reduce the institution’s balance sheet before hiking interest rates.

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Writing for Bloomberg Opinion, Bailey said such a plan would give officials more firepower in future crises. The BOE’s balance sheet has swelled to almost 700 billion pounds ($864 billion) because of its extraordinary measures during the coronavirus pandemic, and is set to grow much larger because of the central bank’s bond-buying program.

Read Andrew Bailey’s full Op-Ed: Central Bank Reserves Can’t Be Taken for Granted

While the governor didn’t say whether he favors paring back that program or its lending facilities first, asset purchases make up the bulk of the BOE’s balance sheet. Before the coronavirus pandemic, Bailey’s predecessor Mark Carney said the central bank would wait until rates hit 1.5% before reducing its stock of assets.

The BOE's balance sheet has exploded over the past decade

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The BOE’s balance sheet has exploded over the past decade

“Elevated balance sheets could limit the room for maneuver in future emergencies,” Bailey wrote. “When the time comes to withdraw monetary stimulus, in my opinion it may be better to consider adjusting the level of reserves first without waiting to raise interest rates on a sustained basis.”

The pound briefly pared its gains on the comments. It traded at $1.2397 at 11:41 a.m. London time.

“The rates versus balance sheet relationship has been flipped,” said James Rossiter, an economist at TD Securities who used to work at the BOE. “What it’s telling us is that the balance sheet is not going to stay this big for very long. In the same sense that the easing was very rapid and targeted, as we normalize the BOE will not hesitate to undo some of that policy.”

That message is a warning shot to the multi-trillion dollar money market industry, which should be a key source of liquidity but which started to dry up when the crisis hit, forcing the BOE to step in. The central bank has already criticized the apparent vulnerability of such funds, which faced difficulty selling assets to meet redemptions despite supposedly investing in short-term, low-risk securities.

John Billingsley wearing a suit and tie: Andrew Bailey Takes Overs As BOE Governor As Coronavirus Hits The Economy

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Andrew Bailey Takes Overs As BOE Governor As Coronavirus Hits The Economy

Andrew Bailey

Photographer: Jason Alden/Bloomberg

“Rather than having to keep relying on central bank support for all aspects of the financial system, we need a robust assessment of the latter’s weaknesses,” he said. “The role of money market funds, and the risks to financial markets that they posed at the height of the disorder, is one area to examine.”

Since Bailey became governor in March, the central bank has cut rates to 0.1% and announced plans to increase its asset-purchase target by 300 billion pounds to contain the economic impact of the pandemic. It has also loaned money on generous terms to keep liquidity high.

a screenshot of a cell phone: Scale of the Challenge

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Scale of the Challenge

The economic slump remains deep. Manufacturing order continued to fall sharply in June, a Confederation of British Industry survey showed Monday. In separate remarks for a Sky News podcast, Bailey said that previously viable businesses may collapse.

The BOE’s bond-buying will lead to an increase in the total stock of assets of at least 66% in 2020, an expansion Bailey says in his op-ed “mustn’t become a permanent feature.”

The financial system mustn’t become reliant on these extraordinary levels of reserves,” he said.

The governor didn’t mention negative interest rates or yield curve control. He has previously said all policy tools are still on the table and that the bank would review the impact of sub-zero borrowing costs.

By indicating that QE is now the main policy lever though, Bailey is sending an “implicit signal” that negative rates are not being seriously considered, former BOE policy maker Andrew Sentance said in a tweet.

The BOE may have to ease even further before it can consider reining in stimulus. The U.K. will face the greatest economic hit from the pandemic of all developed countries this year, according to the OECD.

Both the European Central Bank and the U.S. Federal Reserve have massively boosted their asset-buying again this year, along with extensive lending programs. ECB policy makers have pledged to maintain their stock of purchases “for an extended period of time” past the date when officials start to raise rates.

The BOE last week increased its bond-buying plan by 100 billion pounds, bringing its total target to 745 billion pounds, the equivalent of almost 40% of U.K. gross domestic product.

A previous expansion in March has been widely credited with calming a period of intense market stress in the early days of the pandemic, and keeping a lid on bond yields as the government stepped up borrowing to fund a massive expansion in spending.

Bailey said the action “helped counteract the economic and market turmoil,” and rejected claims the buying — which almost exactly matched the government’s extra debt sales — compromised the BOE’s independence.

“The fact that the predominant borrowers in this emergency are governments, reflecting the essential role of the state in such a crisis, makes no difference to the underlying economics or the importance of keeping borrowing costs consistent with central-bank objectives,” he said. The BOE’s “capacity to act must be reinforced and not mistakenly called into question.”

(Updates with more Bailey comments, CBI survey in 10th paragraph)

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