The Bank of England’s rate-setting meeting this week may not result in a rate change, but there are other issues in motion that bond investors will be watching closely, including the Bank’s plans to continue reducing its government bond holdings.
Recent macroeconomic data has effectively ruled out near-term rate cuts. Inflation remains stuck at 3.8%, almost double the government’s 2% target, while growth remains pallid at 0.2%.
Unemployment data on Tuesday and inflation figures on Wednesday are expected to confirm the current picture, repeating last months’ 3.8% inflation, 4.7% unemployment and rising labour costs.
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At the Bank’s last rate decision in August MPC members were almost equally split into hawks and doves with four members voting to cut rates by 25 basis points to 4%, and four members voting to keep rates at 4.25%. One final vote for a 50 bps cut finally brought about the rate cut to 4%. The split in this week’s MPC vote will also be closely watched for signals on whether a cut is on the table in November or is more likely to be pushed into next year.
This will have two implications for gilts and corporate bonds. Yield levels are likely to hold steady for the next two months, including on high-yield corporate bonds, but new issuances are expected to be postponed until later in November, as companies hold out for cheaper debt.
Investment grade corporate bonds tend to trail gilts more closely than high yielders and once we get closer to November we could see investment grade bonds nudge higher and their yields drop slightly with the move muted slightly due to credit spreads.
Bank of England’s gilt sales plans
Over the last few years, the Bank of England has consistently shed around £100 billion of government bonds annually as it worked to whittle down its epic holdings through a mixture of direct sales and allowing bonds to mature without reinvesting. The Bank has never openly stated its target level, but estimates place it between £380 and £500bn, down from a peak of £875bn.
As of September, the BoE’s gilts holdings stood at £558.bn across different maturities, making it unlikely that the Bank will continue reducing at the same pace. A figure of between £65-£70bn seems more likely.
While still substantial, the market should be able to absorb this without a hiccup. At £2.6 trillion, the gilt market ranks among the deepest and most liquid in the world, alongside US Treasuries, Bunds and Japanese government bonds.
Well sign-posted sales spread across maturities would likely cause a modest rise in yields as extra supply and higher term premia filter through. The impact may show up more in slightly wider bid-ask spreads rather than outright volatility.
According to the BoE, its previous quantitative tightening at the pace of £100bn per year pushed 10-year gilts yields up by 15-25 basis points. A £70bn programme would likely lift them by 10-18bps.
While a meaningful shift, the BoE has stressed that it wants the process to remain “boring and predictable” – the market will be watching closely to see if it can deliver.
