Borrowing costs fall after Bank of England ‘surprises’ markets with bond sale change
The government’s borrowing costs fell on Thursday, after the Bank of England voted to hold interest rates and chose to end its long-term gilt sales in a major overhaul of its bond sale programme.
The yields on both short- and long-term government bonds fell in the aftermath of the decision, as traders pared back bets on the extent of monetary tightening and priced in the lower supply of gilts that will be hitting the market.
Borrowing costs on the two-year gilt fell eight basis points – nearly a tenth of a percentage point – erasing lost ground from a major sell-off over the past 10 days. Investors also added to bets on the 10-year gilt, the benchmark for a government’s long-term capacity to borrow, which saw its interest rate fall nine basis points through Thursday afternoon.
As expected, the Bank of England’s Monetary Policy Committee opted to keep its base rate unchanged on Thursday, despite warning inflation was set to top four per cent before the end of the year. Six members of the influential cohort voted to hold Bank Rate at 3.75 per cent, leaving three – including chief economist Huw Pill – calling for a 25 basis point rise.
Some analysts had predicted deputy governor Claire Lombardelli would add her name to the list of dissenters, in what would have made the decision the closest vote since February. But the split remained unchanged from Threadneedle Street’s last decision in July, leading the UK’s shorter term bonds to rally.
Rate-setters argued evidence of so-called second-round effects, whereby sudden price rises from a supply shock filter into the wider economy, was yet to show up in official data, despite the recent re-escalation of Iran war.
Governor Andrew Bailey said there had been a “material increase in energy prices since July, with a consequent effect on the near-term inflation outlook”.
“If the conflict in the Middle East persists for an extended period, as appears to be the case, and the risk of second-round effects emerging increases, it is likely that policy may have to tighten,” he added.
Borrowing costs fall after QT overhaul
Borrowing cost movements were sharpest among the government’s longer-dated bonds, which the state pays back over longer – often multi-decade – time horizons. The yield on the 30-year bond fell as much as 12 basis points from highs not seen this century, after the Bank of England announced plans to halt its sales of all long-term debt.
Alongside its interest rate decision, Bank officials unveiled a major shake-up to the way it unwinds the decade-and-a-half of bond purchases it carried out in the wake of the 2008 financial crisis. As part of the proposed overhaul, which suggests selling gilts directly to the Treasury instead of onto the open bond market, the monetary authority would end all planned sales of that long-term debt, opting instead to keep it on its balance sheet until they mature.
“Halting active long-end sales this year was not a surprise, but pausing sales altogether and opening the door to an alternative sales model did surprise markets,” Modupe Adegbembo, economist at Jefferies, said, adding: “Active sales are not the only reasons for long-end gilt underperformance, but reducing the likelihood of future sales removes an important source of pressure on the sector.”
The Bank of England had been accused of adding to pressure on long-dated government bonds and stoking borrowing costs with its previous approach to the unwind – known as quantitative tightening. Investors have increasingly demanded a higher coupon to buy 10-year and 30-year gilts, amid fears inflation will remain higher for longer and concerns over runwaway government borrowing.