Mixed in with the Bank of England’s decision on Thursday to hold interest rates at 3.75% was a surprise announcement that it was shaking up its programme of quantitative tightening.
So why is this apparently arcane change to QT important, and what does it mean for the public finances?
What is QT?
It is the Bank of England’s controversial process of selling off hundreds of billions of pounds worth of government bonds that it bought via the emergency policy of quantitative easing (QE) during the financial crises of 2008 and Covid.
The Bank’s monetary policy committee (MPC) sees QT as the necessary unwinding of the massive balance sheet it built up. Its stockpile of bonds, known as gilts, has already been reduced from a peak of £895bn in February 2022, to £488bn.
But critics on the right and left have complained that selling off significant quantities of government bonds costs the Treasury, as they are being sold at a loss.
There have also been concerns that in a febrile bond market, large-scale sell-offs risk depressing prices – and thus driving up the yield, or interest rate, the government has to pay to borrow.
What is the Bank looking to change?
Instead of looking for private-sector buyers for its stock of gilts, the Bank plans to sell them directly to the Treasury instead.
The Treasury’s debt management office (DMO), which has the job of doing the government’s borrowing for it, will then issue new bonds to cover the costs of those it has bought from the Bank.
The Treasury sees this as simplifying what can be a messy process. As the chancellor, John Healey, put it in a letter to the Bank’s governor, Andrew Bailey, on Thursday: “This sales model … would see a return to a single public-sector supplier of gilts to the market.”
It also has the advantage of allowing the DMO to tailor gilt sales to market demand, which currently favour gilts that mature over a shorter period, rather than the Bank having to sell off the 20- and 30-year dated gilts it still has on its books, for which there is less investor appetite.
The yield, effectively the interest rate, on 30-year gilts dropped sharply on Thursday after the decision was announced, to 5.745% – and was on course for its biggest drop since 2020.
No final decision has been made, however, despite the fact the Treasury, Bank and DMO have apparently been discussing the idea for a year. Healey has promised to make a final ruling in April – and until then, QT will be paused.
Wasn’t QT already being slowed down?
Yes. The Bank has run down its stock of gilts by £70bn this year. That included £20bn of actual sales; and another £50bn worth that reached their maturity date.
Over the coming years, it plans to sell off £20bn of government bonds annually, alongside retiring gilts that reach maturity.
That’s because the Bank is keen to avoid the risks of exacerbating already-fragile bond markets. The minutes of the MPC meeting revealed that members discussed offloading bonds at a faster rate; but “at a time when bond markets globally had been volatile, this risked destabilising markets”.
The Bank also announced it would set aside about £120bn of the longest-dated government bonds it holds, as these are used to back the issuance of the UK’s bank notes.
In total, the Bank expects to sell a total of £146bn of gilts between now and 2034 – at a steady pace of £20bn a year – back to the government, if Healey gives the plan the thumbs up.
What’s the impact for the public finances?
Analysts expect it to be modest. The Treasury may be able to finance its borrowing a bit more cheaply when the Bank is not selling a slew of long-dated bonds into the market. As analysts at the investment bank Jefferies put it: “Taken together, the changes imply a materially lower future supply burden, particularly for [long-dated gilts].”
And to the extent that the pace of sales is slowing, the losses on those bonds, which is borne by the Treasury, will crystallise more slowly – another marginal upside.
Jefferies also suggested that, by making its future plans clear, the MPC’s decision could “ease some of the pressure that had been building for changes to the Bank’s QT approach”.