Banks in the UK are increasingly utilizing the Bank of England's (BOE) short-term repo (STR) facility to borrow cash, a strategy that allows them to profit from the spread between the BOE's repo rate and the yield on gilts. On Thursday, banks borrowed a record £100.9 billion ($139.2 billion) from the STR facility, an increase from £98 billion the previous week and a significant jump from about £2 billion in early 2024. This activity is driven by the BOE's ongoing efforts to drain excess liquidity from the financial system through quantitative tightening (QT), which has led to a decline in sterling reserves.
The central bank's shift to a repo-led framework, where banks rely more on borrowing from the BOE for liquidity, has created this arbitrage opportunity. As the BOE reduces its gilt holdings through sales and maturities, sterling reserves have fallen by £286 billion from their early 2022 peak of £979 billion. This reduction in reserves, combined with the central bank's commitment to keep short-term rates near Bank Rate through its facilities, has led to a situation where overnight sterling general collateral (GC) repo rates trade at a positive spread to Bank Rate, typically in the +3 to 8 basis points range, compared to being below Bank Rate prior to QT.
Barclays strategist Moyeen Islam notes that while the BOE's recent decision to slow bond sales might ease some pressure on repo operations, the overall trend of declining reserves and increasing collateral in the system points to a more volatile short-term funding market. The rising usage of the STR facility, which offers a full-allocation mechanism and helps keep short-term rates stable, is seen by participants as a valuable tool for day-to-day liquidity management and for capitalizing on the current market dynamics. This strategy is also influenced by the increasing availability of collateral due to over £600 billion in new gilt issuance and QT since February 2022.
