The Bank of England kept its benchmark interest rate at 3.75% as widely anticipated on Thursday, yet simultaneously cautioned that rate hikes could be necessary should inflationary pressures intensify due to Middle East conflicts. In a significant shift, the central bank also announced major adjustments to its quantitative tightening scheme, declaring a halt to long-dated gilt sales and outlining plans to gradually reduce its £488 billion (approximately $650 billion) debt portfolio by 2034.
Under the not-yet-finalized proposal, the Bank of England will retain £120 billion of gilts maturing in 2049 or later, aligning them with future banknote issuance requirements. An additional £222 billion of gilts maturing by 2035 will be allowed to run off naturally, while the remaining £146 billion set to mature between 2035 and 2049 will be sold at a pace of £20 billion annually, potentially through direct sales to the government via the Debt Management Office. All planned quantitative tightening auctions will be suspended until April of next year to finalize the terms of these sales to the DMO, a move designed to avoid competing with government bond issuance and thereby alleviate short-term pressure on gilt yields.
Where to begin
Barclays strategists indicated that the central bank's decision to moderate its bond-selling pace will ease pressure on repurchase operations while simultaneously providing support to under-pressure ultra-long gilts. Strategist Moyeen Islam noted in a report that this initiative fosters a highly favorable environment for long-dated gilt spreads and the long end of the yield curve, given that a genuine scarcity of bond supply has emerged in the market, a shortage unlikely to be resolved in the foreseeable future. The Bank of England has also effectively reduced a portion of the operational strain on its repo facilities.
Why focus on this approach
The central bank's short-term repo facility provides sterling liquidity to the market using gilts as collateral. The growth pace of these operations had previously outstripped the rate at which the Bank of England was withdrawing reserves through its asset purchase facility, which holds the bonds acquired during quantitative easing. Active quantitative tightening had been driving increased usage of short-term repo operations.
Slowing the pace of balance sheet reduction should allow both short and long-term repo operations to grow at a more gradual rate, granting the Bank of England greater control over the banking system's transition toward an equilibrium reserve level. Meanwhile, certain gilts may become increasingly scarce. According to Barclays calculations, among the central bank's legacy holdings, seven gilts maturing between 2029 and 2034 remain, with six of them having 30% to 50% of their outstanding balances held by the asset purchase facility. With limited prospects for new supply, the quantity of bonds available for trading or lending could diminish further over time, making these gilts relatively more expensive and more sought after in the repo market.
Certain longer-dated gilts held by the asset purchase facility could emerge as candidates for the DMO's tender program, a scheme designed to alleviate market dislocations by selling non-benchmark gilts, taking advantage of their lower yields. Moyeen Islam added that several "fine details" within this new framework still require resolution, including how the DMO will handle the gilts it receives. He noted that September's meeting minutes implicitly referenced discussions within the Monetary Policy Committee regarding the DMO's capacity to cancel bonds, though implementation of this matter would necessitate consultation with the market beforehand.