BoE echoes central banks' long bond sensitivity

Reuters

26-06-2025

LONDON, June 26 (Reuters) - Central banks sense that their once-bloated balance sheets are closing in on the fabled 'steady state', meaning they can concentrate solely on setting interest rates rather than fretting about the monetary effects of adding or shedding bonds.
A curious event at the Bank of England this week was the latest sign of G4 sensitivity to shaky investor demand for so-called long-duration government debt, suggesting policymakers are going to start scrutinizing the effects of their balance sheet activity more closely.
In a parliamentary testimony on Tuesday, Bank of England governor Andrew Bailey said the upcoming annual review of the BoE's balance sheet rundown - or 'quantitative tightening' policy - would be "interesting" this year in light of the sharply steeper UK yield curve.
What's more, he added that central bank reserves in the financial system could reach the top end of estimates from banks for their 'neutral' level during the second half of 2026.
Bailey's deputy Dave Ramsden - who oversees the annual QT review - later concurred with the governor without giving details away, adding "movements at the long end of the curve were a particular focus for us more generally in the Bank."
Partly drawn into the slipstream of sharp moves in long-term U.S. Treasuries, as Donald Trump returned to the White House this year and upended trade and diplomatic policies, long-dated British gilt yields have been on edge all year too.
Even after two quarter-point cuts in BoE policy rates since January, 30-year UK government borrowing costs are 15 basis points higher on the year - and were almost 50bp higher on the year at one point during a turbulent April when they hit their highest in 27 years.
The result has been a near doubling of the yield curve gap between 2- and 30-year gilts - the steepest curve in almost eight years.
Britain has its own home-grown debt worries, memories of a fiscal shock three years ago and limited borrowing room under the current Labour government's own rules at a time of mounting spending demands from defence to health.
There's also a complicated dance between the BoE's bond holdings, how they are funded with interest on commercial bank reserves and the extent to which government is on the hook for losses incurred.
But the nod and wink from the BoE's top brass this week also reflects some concern across major economies about growing indigestion among investment funds for very long-dated debt even as short-term interest rates fall.
Worries about rising public debt and long-term uncertainty about inflation add to the concerns and even changing demographics may be altering the appetite of pension funds for the sort of ultra-long dated debt they once demanded.
Japan's experience has been the spotlight too, with poor auctions of its super-long government bonds lately forcing the Bank of Japan and finance ministry to rethink both the amount of debt it sells at this maturity as well as how much the BOJ will buy and hold.
And the U.S. Federal Reserve has already slowed its QT process to a trickle, with little more than a token monthly runoff now underway.
The Bank of England is unusual, however, in that its QT plan involves both active sales of gilts as well as allowing the bond pile to just mature and roll off in a way other major central banks wholly rely on.
The big question is whether BoE wariness of yield curve swings forces it to reconsider QT altogether or just play around with the range of maturities it's shedding.
A report from Bank of America this month said it expects the BoE to slow the overall bond runoff to 60 billion pounds over the year from October from the 100 billion pace in the current year.
As that would include about 49 billion pounds of maturing debt, active sales would then drop to little over 10 billion. Keeping QT unchanged at this year's pace would mean about half of the drop in 2025/2026 would need to come from active selling.
Even though the BoE continues to say that its QT process has a relatively modest impact on the market, some of its policymakers and the BofA team doubt that and suspect it is actually tightening lending conditions in a way that dampens the effects of its main policy rate cuts.
As the BoE's QT process runs down commercial bank reserves and potentially squeezes lending capacity eventually, the Bank has set up special securities repurchases facilities and urged banks to use them more to manage their liquidity needs.
But BoE rate-setter Catherine Mann said this month that the central bank needs to pay closer attention to the impact of QT.
"Now that the MPC is reducing restrictiveness, I believe that we need to consider the differing effects of our policies on different parts of the yield curve and their effects on monetary policy transmission as a more salient issue," she said.
BofA's team tend to agree, adding the fiscal impact of slowing QT would be 'negligible'.
"We are sceptical whether QT is really operating in the background, not least in light of long-end Gilt price action developments as of late," the BofA report said. "At a time when the BoE is trying to ease monetary conditions by cutting rates, QT could be diluting the pass-through of cuts by tightening monetary conditions at the long end."
Whether the effects are enough to see the end of active gilt sales on the horizon is another question and the debate about where the 'steady state' is for a balance sheet that is still some 130 billion pounds of gilts above pre-pandemic levels will likely build too.
The opinions expressed here are those of the author, a columnist for Reuters