The Bank of England's aggressive strategy of selling government bonds, a process called quantitative tightening, is causing unexpected strains in the money markets. The central bank has reduced its balance sheet from nearly £1 trillion to approximately £760 billion, primarily by selling bonds rather than just letting them mature. This differs from other central banks and is draining liquidity from the market, leading to a cash shortage.
Evidence of this shortage includes surges in short-term lending rates and a significant increase in the use of the BoE's short-term repo facility. Last week, investors borrowed £16 billion from this facility, a sharp rise from under £5 billion early last month. The overnight sterling borrowing rate (Sonia) has edged up to 5.2%, nearing the bank's base rate of 5.25%. Analysts at Barclays, Bank of America, and NatWest suggest that these frictions, occurring sooner than anticipated, may prompt the BoE to slow its balance sheet reduction after its September policy review.
BoE Governor Andrew Bailey acknowledged the increased use of the repo facility as "encouraging" and anticipates a "significant increase" in its utilization, aiming for a "steady state" balance sheet between £345 billion and £490 billion. However, analysts believe the actual steady size needed for smooth market functioning might be considerably larger. Strategists like Mark Capleton from Bank of America suggest the BoE is nearing an "uncertain ceiling" and may halt active gilt sales from September, partly due to a large volume of gilts maturing next year. Tomasz Wieladek of T Rowe Price also warns that a prolonged rise in repo rates could force a slower pace of QT.
