The sharp sell-off in UK government bonds last week is putting pressure on the Bank of England to slow the pace of its gilt sales to ease the government’s rising borrowing costs.
Investors and analysts have warned of the fragility of the gilt market after investors dumped government bonds over fears that Rachel Reeves, the chancellor, did not have the support of Sir Keir Starmer.
Gilt yields recorded their largest single-day rise on Wednesday since the market turmoil caused by Donald Trump’s tariffs in April, before reversing the following day. Yields rise when bond prices fall.
The sell-off came a day after Andrew Bailey, governor of the Bank of England, said policymakers would begin discussing whether to continue selling gilts back to investors, a process known as “quantitative tightening”.
The Bank has been offloading bonds it bought during the 2008 financial crisis and the pandemic back to the market since 2022. Until this year, QT had been coupled with rising interest rates and the Bank’s staff have acknowledged the selling is also helping to tighten financial conditions, which helps to bear down on inflation but slows growth.
As the Bank is now cutting interest rates to support the economy, City businesses have said the pace of bond sales must slow amid fears that investors are unwilling to keep absorbing a higher gilt supply when concerns about the public finances are worsening anyway, which pushes up the yield, making borrowing more expensive. That, in turn, slows the economy.
The current pace of bond sales is £100 billion a year and is likely to be reduced to £80 billion a year from October, Sonali Punhani, UK economist at Bank of America, said. She warned that the Bank’s actions were one of the main factors driving up longer-term government borrowing costs.
“At a time when the Bank is trying to ease monetary conditions by cutting rates, QT could be diluting the pass-through of cuts by tightening monetary conditions. [QT] has been a contributing factor to the underperformance of long-dated gilts versus overseas peers,” she said.
Bailey said last week that the Bank would begin its annual review of the pace of its bond sales but rebuffed investor fears that QT was responsible for the jittery bond markets.
“I don’t believe that quantitative tightening is actually causing the steepening of the yield curve; but the fact that the yield curves have steepened, it’s something that we will obviously look at in terms of the implications of that, the impact of it and how we judge… the appropriate programme for the year ahead,” the governor told CNBC.
The Bank of England is cutting interest rates to support the economy
ALAMY
His comments helped gilt yields to rally on Tuesday before concerns about the chancellor’s future hit bond markets the following day.
Analysts at HSBC said the Bank would maintain its £100 billion pace but mainly sell shorter-maturity bonds to help stabilise 10-year and 30-year bond prices, which are more sensitive to worries about the government’s debt pile and its ability to meet its fiscal rules.
Holger Schmieding, chief economist at Berenberg, said the Reeves-induced sell-off last week was a sign that bondholders remained on high alert for any signs of fiscal slippage in the UK.
“Markets reacted decisively to the risk that the UK replaces Reeves with a candidate less committed to fiscal restraint. Due to the combination of high and rising debt-to-GDP ratios, higher interest rates and the difficulty of imposing spending cuts, investors now question whether governments will be able to meet future debt repayments,” he said.