The Bank of England's decision focuses on QT! Market bets slow down or even halt bond sales.

The market focus for the Bank of England's monetary policy meeting this Thursday at 19:00 has shifted from the interest rate decision to the direction of the quantitative easing (QT) program.

With interest rates expected to remain unchanged, investors are focused on whether the Bank of England will reduce or even suspend its active bond-selling operations. Analysts are divided on the QT outcome, but any reduction in the scale of active bond sales could be beneficial to UK government bonds. Mizuho strategist Evelyne Gomez-Liechti stated:

"QT is a more important market event, and the impact of related announcements may far exceed that of interest rate decisions."

UK government bond yields recently surged to their highest level since 1998, with the continued rise in long-term borrowing costs eroding the government's fiscal space, and the window for next month's budget announcement fast approaching. The market is more sensitive than ever to every detail of the Bank of England's QT strategy.

QT's scale may shrink significantly, and active bond sales may lead to withdrawal.

The Bank of England's QT program aims to gradually absorb the UK government bonds it purchased during the pandemic's quantitative easing operations. Since February 2022, the Bank of England has reduced its portfolio size from approximately £980 billion to £489 billion.

According to a survey of market participants by the Bank of England, the market generally expects it to reduce the pace of balance sheet reduction to £50 billion (approximately $67 billion) per year over the 12 months starting next October, corresponding to an active bond sale of about £20 billion. However, according to a report in The Daily Telegraph earlier this week, the Bank of England may completely stop selling long-term government bonds, a piece of news that has sparked widespread discussion in the market.

Evelyne Gomez-Liechti's baseline expectation is that the Bank of England will shift from active bond sales to purely passive QT—that is, only allowing government bonds to mature and roll off the balance sheet naturally, rather than actively selling them in the secondary market—a shift she believes will support UK government bonds.

The pressure on long-term government bonds is particularly prominent.

According to analysts Fabio Bassanin and Luca Salford of Morgan Stanley, "large-scale government bond issuance coupled with a continued decline in the Bank of England's holdings" has had a particularly significant impact on long-term government bonds, as demand from traditional demanders such as pension funds has shrunk considerably in recent years. The two strategists estimate that the QT operation has already raised the yield on 30-year UK government bonds by an additional 70 basis points.

The premium of 30-year Treasury bonds over interest rate swaps of the same maturity—one of the indicators of market concerns about bond supply—has remained relatively stable this year, even though yields have risen sharply.

At the same time, the current proactive sale of long-term government bonds is being carried out at a loss, causing the British government billions of pounds in losses and further increasing external criticism of the plan.

The effect of suspending bond sales may be limited, and concerns remain about the central bank's independence.

Even with the Bank of England's announcement of a suspension of bond sales, some market participants believe its boosting effect may be quite limited. UK government bonds still face risks from external shocks, such as escalating tensions in the Middle East pushing up oil prices and exacerbating inflation concerns—factors that cannot be resolved by QT policy adjustments.

Remi Olu-Pitan, Head of Multi-Asset Growth and Income at Schroders, stated:

"I do believe that the lender of last resort will need to step in to support UK government bonds at some point. If UK bond yields continue to rise, then action will be necessary."

Furthermore, some market participants have warned that the Bank of England may not make significant adjustments to its current strategy. Citigroup strategist Jamie Searle stated that while adjustments are possible, he tends to believe the Bank of England will "maintain the status quo to avoid blurring the boundaries of monetary policy's control over QT." Market concerns exist that if the central bank modifies its bond-selling strategy to align with government fiscal needs, it could raise questions about its independence.

The Bank of England's stated goal is to eventually clear its entire holding of government bonds, and it has set three guiding principles for this: interest rates will remain the primary tool of the Monetary Policy Committee; bond sales must not disrupt the normal functioning of the market; and the process must be gradual and predictable. Finding a balance between these principles and market realities will be the core challenge of this decision.

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