Market Outlook

For BOE’s Quantitative Tightening Plan, More Surprises Beckon

(Bloomberg) — Already famed for its unpredictability, the Bank of England could get a whole lot more inscrutable as a new tightening tool comes into play.

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So-called quantitative tightening — the process of unwinding years of the BOE’s government bond buying — could kick off if the BOE hikes rates to a key level at its next meeting in February. Yet with the risk of Covid-19 restrictions threatening the economic outlook, traders are speculating on when and how the strategy will be introduced.

Wrongfooting investors and analysts is becoming a BOE hallmark, with recent dramatic market responses to decisions marking a shift from years of relative calm. Mollycoddling markets does not appear to be on the agenda of current Governor Andrew Bailey or Chief Economist Huw Pill.

“It really now is a “meeting by meeting” type outlook,” said Sanjay Raja, U.K. economist at Deutsche Bank AG in London, and one of the few economists to call the BOE’s December’s decision to raise rates correctly.

The market is divining the BOE’s moves from its strategy report published back in the summer. Once its rate reaches 0.5%, the central bank said it would stop reinvesting the proceeds of its maturing notes — reducing its portfolio automatically when the debt is due. That’s leading to bets on a steeper gilt curve as longer-dated debt would bear the brunt of QT.

Traders Ramp Up Bets for U.K. Rate Hikes in 2022 After BOE Shock

Strategists from banks including Deutsche Bank, RBC Capital Markets, Nomura International Plc and Mizuho International Plc are predicting the BOE will reach that key 0.5% level in February 2022. That would see a 28 billion-pound ($37 billion) redemption due in March wiped off the central bank’s books and mark the end of BOE interventions in the market for the foreseeable future.

The BOE’s next step would mean a potential active sale of gilts after the rate reaches 1% — a level money markets see being hit in August.

In practice, with the U.K. government leaving the door open to further Covid-19 restrictions and with cases close to record highs, analysts are warning that the dent to the economy could stymie a straightforward implementation of the QT strategy.

A decision to delay hiking rates until March throws up the “admittedly odd” possibility of the BOE doing an “interrupted” reinvestment of the March redemption, wrote Bank of America Corp. strategists Agne Stengeryte and Mark Capleton in a note. With the bond in question maturing on March 7 and the next rate decision following 10 days later, the BOE could end up reinvesting around six billion pounds before stopping, they said.

“The key message here is that a failure to reach the 50 basis-point threshold by the February meeting doesn’t completely rule out quantitative tightening starting in March,” they said.

Tightening Impact?

There’s still a fundamental question mark hanging over QT: no one knows for certain how much tightening impact it could create and, therefore, how the BOE will factor it in as part of its overall strategy over coming years.

The BOE has previously said that 60 billion pounds worth of bond buying is equivalent to around 50 basis points of cuts, but it isn’t clear whether this approximation will stand in reverse. Strategists at Mizuho including Peter Chatwell argue that the impact of stopping reinvestments will be “limited.” And the active sale of gilts is another conundrum altogether.

From a supply-demand perspective, the consequences are clearer. If QT doesn’t go ahead in March, net gilt issuance that month would tip into “sharply negative territory” of around minus 6.3 billion pounds, when factoring the full reinvestment, according to Bank of America calculations. Gilt investors have already been struggling with a dearth of paper since the U.K.’s debt management office unexpectedly slashed issuance for this fiscal year in October.

The diversity of options for the BOE is not only stirring uneasiness among gilt investors but also among international bodies. The International Monetary Fund stressed the importance of improving the predictability of the QT strategy to “avoid markets second guessing.”

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