LONDON: The Bank of England (BoE) 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.
Forecasters including Oxford Economics and HSBC Holdings Plc expect the central bank to limit sales of its remaining £163bil (US$219bil) 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.
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.
A 30-year bond selloff in response to rumours 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’ short-lived premiership.
Some analysts have warned the BoE may be contributing to the volatility through quantitative tightening (QT) as it competes for buyers with a big-borrowing government at a time when demand from defined-benefit pension funds is waning.
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 said the Monetary Policy Committee (MPC) could announce that most of its holdings of long-dated debt will never be sold under a new strategy.
“The main effect would be to reduce risks that the BoE’s QT programme further destabilises the gilt market,” Saunders said.
The BoE has been reducing its bond holdings, which peaked at almost £900bil, by about £100bil a year.
This year, it planned to do so through £13bil of active sales and by letting £87bil of maturing debt run off.
However, a lower level of bond redemptions due in the next year would imply far more sales if the £100bil pace is maintained, potentially posing a market risk.
Investors surveyed by the central bank expect it to slow the QT process by £25bil, implying just £26bil 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 were previously expected.
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 MPC 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.
Saunders’ plan would see the bank continue to unwind the £290bil of gilts with a term of three to 20 years but hang onto the £163bil of long-dated gilts, those with over 20 years left to run.
About £120bil of the long-dated portfolio would be written down to the £93bil nominal issue price, crystallising a £27bil loss as a one-off rise in government debt.
Those assets would then be held against the BoE’s matching £93bil of currency liabilities, effectively notes and coins in circulation. — Bloomberg