This Thursday will see a Monetary Policy Committee (MPC) meeting at which rate setters will debate whether to raise interest rates to 5.5pc. Inflation data the day before is expected to show an acceleration in price rises in August and will fuel debate.
Yet the meeting may also see the MPC agree to ramp up the pace of bond sales as it speeds up efforts to shrink its massive balance sheet.
In July Sir Dave Ramsden, a deputy governor, said he sees potential to “increase slightly the pace of gilt stock reduction”.
The Bank is seeking to offload more than £700bn of bonds it snapped up in the aftermath of the 2008 financial crisis and the pandemic to help support the economy.
However, analysts think the Bank could opt to ramp up sales to as much as £15bn a quarter under the process known as quantitative tightening (QT).
The pace of maturities is also set to rise to around £55bn per year as more gilts reach the end of their term.
If sales are ramped up, officials at the Bank will be hoping they do not see a repeat of the volatility seen this time last year.
The meltdown after the mini-Budget forced it to pause QT and in fact begin buying bonds.
Conditions this time around are far calmer – but the process is not without risk. Furthermore, it presents a headache for the Chancellor as the Treasury will be landed with the bill for any losses the Bank incurs from selling gilts.
The Bank of England had been planning how to sell bonds into financial markets since the moment it first bought them when Mervyn King launched quantitative easing (QE) in 2009.
In the teeth of the financial crisis, unable to cut interest rates any further, the Bank started creating money to buy bonds in an effort to keep money following in the financial system.
It became the favourite policy to use during the turmoil of the subsequent decade – and one officials seemed unable to reverse.
By its peak in 2022, the mountain of assets purchased had ratcheted up to £875bn of government bonds and £20bn of corporate debt. It was far more than anyone imagined back in 2009.
A year ago the Bank began selling the debt back into financial markets.
Almost immediately, the bond markets descended into chaos. Quantitative tightening (QT) was nearly derailed the moment it launched. However, after order was restored to the bond market, sales continued.
“It has gone extremely well,” says Katharine Neiss, chief European economist at PGIM Fixed Income, and formerly of the Bank of England.
Selling £80bn of gilts over a year might sound large, but compared to the pace of bond purchases under QE it is relatively slow, says Melanie Baker at Royal London Asset Management.
“It is not just QE in reverse. That was intended to have a ‘shock and awe’ impact when it started – they want to have the absolute opposite with QT, working in the background,” she says.
Paul Fisher, who served on the MPC at the launch of QE, says the lack of public focus shows QT’s success: “You notice these things when they go wrong.”
Policymakers meet the day after the Office for National Statistics publishes August’s inflation numbers. Economists expect a rise to 7pc or more, accelerating from 6.8pc in July on the back of rising petrol prices.
However, there are complaints that the Bank’s policy package is bad news for the Treasury.
Rising rates push up the Government’s debt interest costs and the gilts are being sold into the market at a loss to the public purse.
The Bank bought most of the gilts when interest rates were very low and bond prices were high.
As it has raised interest rates, the price of bonds have dropped as better returns are available elsewhere. This means the Bank loses money if it sells the gilts at a price below that at which it bought the assets.
When QE began, the Treasury agreed to cover any losses from the scheme.
Funds are transferred every three months as required. In July alone, the Treasury transferred £14.3bn to the Bank under the terms of the indemnity, ONS figures showed.
Sir John Redwood, a Conservative grandee, says: “The Bank should not sell any more bonds in the market creating huge losses for the Treasury and taxpayers to pay.”
The scheme made a significant profit for the Treasury in its earlier years, but the rundown is more painful.
Christopher Mahon, of Columbia Threadneedle Investments, has warned: “The losses of the QE experiment are huge. Even the Bank’s own numbers project eye-watering losses. Figures published by the Bank in August suggest over its lifetime, QE is likely to cost the state a net £110bn, around 5pc of GDP.”
The MPC is not supposed to worry about costs to the Treasury when setting policy and nor was it influenced by the positive cash flows to the Exchequer earlier in the scheme.
However, Yael Selfin, chief economist at KPMG, says the Bank could easily hold off on QT to reduce the hit to the public purse.
“There seems no obvious urgency to accelerate QT in order to create additional room in case QE was needed,” she says.
“And as expectations are that interest rates will start falling again in the medium term, selling more bonds when rates are lower will lower the losses that will need to be borne by the Treasury.”
The Government is still on track to borrow in the region of £130bn this financial year, so an extra £80bn – or more – of gilts landing in the market from the Bank of England is not insignificant.
Bond yields have already risen above those in the US and are close to levels seen during the mini-Budget meltdown, although they are not wildly out of whack in a world where borrowing costs are rising across the board. Ramping up QT even further may push bond yields even higher, however.
Andrew Sentance, who was a member of the MPC in 2009, believes the market has the capacity to absorb QT.
“There is a lot of demand out there for quality government debt as a financial asset for the private sector to hold,” he says.
A year on from the bond market meltdown that followed the mini-Budget, Bailey and his colleagues will be hoping that’s the case.
