Market News

By David Milliken

LONDON (Reuters) -The Bank of England is expected to soon slow the pace at which it shrinks its 558 billion-pound ($754 billion) holdings of government bonds, and economists hope next week will shed some light on its longer-term goals for the stockpile.

Alongside a predicted quarter-point interest rate cut to 4%, the BoE's Aug. 7 policy statement will assess the past year's quantitative tightening, or QT, before policymakers decide in September on the pace of bond sales for the following 12 months.

There is greater uncertainty over QT than usual due to recent bond market ructions and because liquidity in Britain's financial system is approaching a balanced level for the first time since before the 2008 financial crisis.

Adding to the mix is political pressure over the hefty losses the BoE has made when selling bonds.

"The official view from the Bank ... is that they see this as an operation that works almost in the background. But clearly it has come to their attention that they are not operating in a vacuum," said Peter Schaffrik, global macro strategist at RBC.

Unlike other big central banks, the BoE's QT programme involves bond auctions as well as letting existing holdings mature.

Over the past year, it has sold 13 billion pounds of gilts and let 87 billion pounds mature. Keeping up that 100 billion-pound pace for the next 12 months would require it to sell a record 51 billion pounds though, due to fewer redemptions.

Schaffrik said market conditions had changed since it last sold close to 50 billion pounds of gilts, however, which was in the year to September 2024.

"The market would probably take it quite negatively if they sold such a large amount," Schaffrik said.

The BoE itself has said its sales so far have barely pushed up government bond yields.

A BoE survey published in May showed investors mostly expected QT to slow to a yearly 75 billion-pound pace from September and to 50 billion in 2026-27 before active sales effectively end in 2028.

EARLY END TO BOND SALES?

One outlier is BNP Paribas' Europe economist Dani Stoilova, who expects the BoE to stop gilt sales from October onward to avoid impacting the market.

British 30-year government bond yields hit their highest levels since 1998 in April after President Donald Trump's tariff bombshell rocked the markets and the BoE had to postpone a bond sale.

Despite four BoE rate cuts over the past year, the difference between five- and 30-year gilt yields has doubled to 1.4 percentage points and the 2/10-year yield curve has steepened to 0.75 percentage points from near zero.

"Active QT has never been done in this environment where Bank Rate has been falling. And so there is the potential that there are interaction effects that haven't been caught," Stoilova said.