Bank of England Urged to Hold Back Long-Dated Bonds From Market

os(em7pn[683ojwa40r}]s4g_media_dl_1.png Office for Budget Responsibility

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(Bloomberg) — The Bank of England is facing pressure to hold onto more than a quarter of its bond holdings, potentially for decades, after recent market turmoil highlighted the fragility of demand for long-dated UK government debt.

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Forecasters including Oxford Economics and HSBC Holdings Plc expect the central bank to limit sales of its remaining £163 billion ($219 billion) of gilts with a term of over 20 years, or even stop the disposals altogether, in a shift to the way it is reducing its crisis-era balance sheet.

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The BOE is selling its gilts portfolio, which was built up over more than a decade of quantitative easing, amid warnings of heightened volatility as a market once dominated by steady buyers such as pension funds becomes more dependent on flightier hedge funds and foreign investors.

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A 30-year bond selloff in response to rumors this month that Chancellor of the Exchequer Rachel Reeves was about to be fired delivered a stark reminder of the new reality. The episode had echoes of 2022, when long-dated gilts were at the heart of the market crisis that ended Liz Truss’s short-lived premiership. 

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Some analysts have warned the BOE may be contributing to the volatility through quantitative tightening as it competes for buyers with a big-borrowing government at a time when demand from defined-benefit pension funds is waning.  

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Among those advocating for a change in BOE policy is Michael Saunders, a former BOE rate-setter and now senior adviser at Oxford Economics. He says the Monetary Policy Committee could announce that most of its holdings of long-dated debt will never be sold under a new strategy.

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“The main effect would be to reduce risks that the BOE’s QT program further destabilizes the gilt market,” Saunders said.

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The BOE has been reducing its bond holdings, which peaked at almost £900 billion, by about £100 billion a year. This year, it planned to do so through £13 billion of active sales and by letting £87 billion of maturing debt run off.

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However, a lower level of bond redemptions due in the next year would imply far more sales if the £100 billion pace is maintained, potentially posing a market risk. 

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Investors surveyed by the central bank expect it to slow the QT process by £25 billion, implying just £26 billion of active sales. BOE Governor Andrew Bailey has recently noted a “change in the liquidity of the curve at the long end and that has affected yields,” hinting at fewer future sales than was previously expected. 

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QT is costing the Treasury tens of billions of pounds in both interest-rate and valuation losses on the sales, putting the BOE under rising political pressure to get the debt off its balance sheet. However, the Monetary Policy Committee is likely to take a cautious approach as it decides how fast to go from October, Saunders said. The BOE is set to provide its latest analysis at its meeting on Aug. 7, with a decision due in September.