Analysis-Bank of England poised to slow QT after rise in yields

The Bank of England is anticipated to slow the pace of its £558 billion quantitative tightening (QT) program, with an August 7th policy statement assessing the past year and a September decision on the next 12-month pace. This expected deceleration is influenced by recent bond market volatility, nearing balanced financial system liquidity, and political pressure over bond sale losses. Maintaining the current pace would necessitate record gilt sales that analysts fear could negatively impact markets, especially given the ongoing rate cuts and the unprecedented environment of active QT alongside falling Bank Rate.

Analysis

The Bank of England is approaching a critical juncture regarding its quantitative tightening (QT) program, with market consensus pointing towards a slowdown from the current £100 billion annual pace. This expectation is driven by a confluence of factors, including recent bond market volatility, political sensitivity over realized losses on gilt sales, and financial system liquidity approaching a balanced state for the first time since 2008. Maintaining the current pace would require a record £51 billion in active gilt sales over the next year, an amount that strategists like RBC's Peter Schaffrik believe the market would absorb negatively. This is compounded by an unprecedented policy environment where active QT is occurring alongside a cycle of interest rate cuts. The resulting steepening of the UK yield curve, with the 5s30s spread doubling to 1.4 percentage points, has raised concerns about unintended policy interactions, as acknowledged by Governor Andrew Bailey. While the BoE maintains that QT has had a minimal impact on yields, the uncertainty has led some analysts, such as BNP Paribas, to forecast a complete halt to active sales. The central bank's long-term plan for its balance sheet remains unclear, but growing usage of its repo facility suggests that the minimum desired level of bank reserves may be reached sooner than official estimates indicate, adding further weight to the case for a more cautious and slower pace of QT going forward.

Key Decisions for Investors

• Investors with UK fixed-income exposure should anticipate continued volatility and watch the BoE's September decision closely, as a QT pace above the expected £75 billion could exacerbate yield curve steepening.
• Given the unprecedented environment of simultaneous rate cuts and active QT, it is prudent to monitor for signs of market dysfunction or liquidity tightening, such as increased usage of the BoE's repo facility, which could signal a more abrupt policy shift.
• Pay close attention to official commentary on the interaction between QT and monetary policy, as any signal that the BoE might alter the maturity of its gilt sales or use QT to manage the yield curve's slope would have significant implications for duration-based strategies.
• The inherent uncertainty and mixed signals from policymakers suggest a cautious stance, as the risk of a policy misstep or a market overreaction to the BoE's QT announcement remains elevated.