The Bank of England (BoE) is widely expected to keep its benchmark interest rate, the Bank Rate, on hold at 3.75% during its upcoming meeting. This decision comes despite the U.S. Federal Reserve raising its borrowing costs a day earlier and surging energy prices which are stirring talk of a potential rate hike in the UK. Financial markets are pricing in an 80% chance of a quarter-point rate hike by November, with around four such hikes expected over the next year.
However, the more significant announcement for bond markets is anticipated to be the BoE's decision on quantitative tightening (QT). The central bank is expected to slow the pace of its balance sheet reduction, with the annual target for gilt stock reduction likely falling to around £50 billion from the current £70 billion. This reduction is primarily driven by a lower volume of naturally maturing gilts, estimated to drop from approximately £49 billion to £30.5 billion.
Crucially, there are strong indications that the BoE will halt active sales of 20- and 30-year gilts, concentrating sales instead on shorter and medium-dated bonds. While overall active gilt sales are projected to decrease only slightly from £21 billion to around £19.5 billion, this shift in composition aims to alleviate pressure on the long end of the gilt curve, where yields have risen sharply. This move to reduce direct supply pressure from QT in the long-dated market is seen as a more impactful decision than the rate hold, with some reports even suggesting the BoE might sell gilts directly to the Debt Management Office (DMO) rather than through market auctions.
Deputy Governor Ramsden has previously stated that QT's impact on gilt yields is modest, contrasting the 20-30 basis points attributed to cumulative QT with the approximately 200 basis points increase in the 10-year term premium since early 2022. Nevertheless, the market is closely watching the maturity composition of the QT program, anticipating a separate Market Notice detailing the operational framework for these changes.
