Criticism of the Bank of England is on the rise, with approval rates at a historic low in the independent era. However, it is important to acknowledge the commendable efforts of Bank officials in navigating the UK through an inflationary shock caused by external factors and now into an inflationary shock driven by factors within their control. While they still have progress to make, they are at least on the right track.
The upcoming events of Wednesday’s consumer price index inflation reading and Thursday’s Monetary Policy Committee meeting are of utmost importance. Additionally, Goldman Sachs has provided valuable insights into the Bank of England’s quantitative tightening framework, in which they are reducing their pandemic-era stockpile through active selling and allowing mature gilts to roll off their portfolio.
When we previously discussed QT in September, the issues within the gilt market were already apparent. The Bank was preparing to sell gilts actively while the government planned for a significant wave of further issuance. This led to a flooded market with increased supply and resulting price decreases.
The “fiscal event” in late September caused a delay in active sales, but they have now resumed, and the Bank’s asset purchase facility holds £808bn worth of gilts, down from £875bn in February. However, reaching the target of reducing that number to £325bn-£480bn poses a considerable challenge, according to Goldman’s analysts.
Going forward, there are three main reasons why Goldman Sachs believes the Bank of England will slow down the pace of active sales. First, there will be a meaningful increase in net gilt supply to the private sector due to higher issuance and APF redemptions. Second, the volatility and reduced liquidity caused by inflation and labor market surprises create challenges in the gilt market. Finally, the repricing of gilt yields implies higher debt interest costs and potential losses for the Bank.
Estimating the slowdown in active sales is challenging due to the uncertainty surrounding market conditions. Goldman’s baseline prediction is a reduction to £7.5bn per quarter with an unchanged annual stock reduction target of £80bn next year. However, they believe the hurdle for the Bank to further reduce the speed of active sales to around £5bn per quarter is low, as it would depend on their conversation with market participants and their willingness to absorb gilt supply.
Currently, gilt yields primarily put political pressure on the government, but this could spill over to the Bank of England. The Bank has shown a reactive approach to issues in the gilt markets, as seen in the early and intense trial by fire last autumn.
However, the Bank is not without its flaws. Despite having a stronger market presence at the front end of the curve, it announced that it would distribute sales evenly across all three maturity segments, ignoring the scarcity of short-dated gilts. The MPC also likely has a higher threshold to identify weakness in the gilt market compared to market participants.
Forecasters are skeptical of the Bank’s stated QT plans, estimating £70bn of stock reduction next year instead of the £80bn target. This would result in a slowdown of active sales to around £5bn per quarter. The timing of Goldman’s note coincides with a potential increase in active sale plans.
Lower prices make hitting targets more difficult and create a challenging volume/value dynamic. While a slowdown in QT may relieve some pressure on rates and reduce costs for the Treasury, its impact may not be significant enough to significantly influence the government or the Bank. Assessing the precise effects of QT on monetary conditions remains challenging. Ultimately, the Bank’s role in pushing gilt rates over the past year may be viewed unfavorably if a slowdown proves to have little consequence.
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