(Bloomberg) -- The Bank of England’s decision to bolster liquidity management tools for major financial institutions has some economists thinking the central bank could maintain or even accelerate — not slow down — its asset-sales plan under quantitative tightening.
The move, if confirmed by the BOE next month, would crystallize losses on bond sales more quickly than currently forecast, potentially adding to strains on the UK Treasury.
Some economists had thought the BOE might slow the pace of bond sales to avoid unsettling markets following a sharp pick-up in the use of its liquidity operations in recent weeks. That would have given Chancellor of the Exchequer Rachel Reeves as much as £10 billion ($12.8 billion) of extra spending power for struggling public services like prisons, health and local authorities.
Instead, economists now expect the BOE to press ahead with existing QT plans or even accelerate the pace of gilt sales, which are currently running at £100 billion a year. The BOE is keen to sell off the assets to reduce interest-rate risk it has on the portfolio, but doing so leaves the Treasury with a bill for losses on the program. A faster unwind leads to deeper losses, making the Chancellor’s choices harder.
Reeves on Monday said the previous Conservative government ran up £22 billion of undisclosed and un-financed spending commitments, requiring her to trim back some programs and signal she might have to raise taxes in a budget statement she will make on Oct. 30. It leaves the Treasury with what she described as “the worst inheritance since the Second World War.”
The shift in sentiment about the BOE’s intentions follows last week’s announcement that the bank will expand its tools for cash management used by financial institutions. That program is meant to smooth market functioning as the BOE offloads gilts bought under quantitative easing from 2009 to 2021. The BOE still has £691 billion of bonds in a portfolio that peaked at £875 billion.
Under QE it bought gilts in exchange for cash-like reserves that financial institutions held. It is moving to a system of lending cash against those assets, a liquidity arrangement known as “repos.”
Sanjay Raja, chief UK economist at Deutsche Bank, had thought the BOE would slow its QT program at the next annual update in September. Following a speech last week on repos by Vicky Saporta, the BOE’s executive director for markets, he thinks officials may speed up the unwind from the current pace of £100 billion a year.
“We think this could rise to as high as £127 billion,” Raja said. Jack Meaning, chief UK economist at Barclays, expects the BOE to commit to another £100 billion in September and to send a signal to that effect alongside the interest rate decision on Thursday.
What Bloomberg Economics Says ...
“All the signs point to repos being the preferred mechanism for providing liquidity to the market. The upshot is that the pace of QT doesn’t look like it will slow any time soon. We expect another £100 billion envelope to be announced in September. The risks are tilted toward the Bank announcing a larger figure.”
—Dan Hanson, Bloomberg Economics.
The BOE declined to comment. It’s due to announce a new annual program for QT asset sales in September.
There has been a big increase in the use of the BOE repo facilities over the past few weeks as gilts were sold. Market participants claim the stable level of reserves could be higher than the BOE’s current top estimate of about £490 billion, according to minutes from last month’s BOE money markets committee.
Saporta warned at an event last week that the pinch point may come “as soon as next year, so we all need to be ready. What worries me the most is that we may not be ready for it.”
The BOE is keen to sell off the gilt portfolio as quickly as possible because it wants to remove the interest rate risk that comes with holding those assets. Since 2022, the portfolio has lost more than £60 billion — a sum the UK Treasury is required to cover under a guarantee set out at the start of the QE program in 2009.
However, accelerating asset sales rather than letting them mature brings forward additional losses, creating a stronger fiscal headwind for the Chancellor. Some economists and bond investors believe the BOE might end active sales, saving Reeves £10 billion a year.
Meaning said ending active sales appears less likely now because the BOE seems confident that it can sell the gilts and replace them with repos without causing market turbulence. “As such we think the bar to continuing QT and selling active bond holdings has been reduced further,” he said.
Raja said the money markets committee minutes showed that participants think the repo operations are working well. “This to me could give the BOE the green light to go ahead with active sales in the upcoming QT round and perhaps maintain a more sizeable sales pace than what the markets are expecting. We think this could rise to as high as £127 billion.”
--With assistance from Andrew Atkinson.
©2024 Bloomberg L.P.
