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The Bank of England is widely expected to hike Bank Rate to 0.5% in February, the point at which the Monetary Policy Committee has made it pretty clear that it will press ahead with all-out non-reinvestment of maturing assets rather than attempting any fine-tuning of its natural run-off policy.

The natural run-off will move slowly in fiscal year 2022/23 starting in April, with only GBP9.13 billion of gilts at purchase value set to mature. But on March 7, there is a chunky GPB27.49 billion maturing, leading some analysts to speculate that the Bank could announce only partial non-reinvestment of those proceeds.

That, however, looks implausible as the Bank's guidance -- outlined in last August’s quarterly statement -- has been that a natural run-off will be automatic, with the only exception an economic conditions test which would include stressed markets, which is not applicable at present.

While the MPC gave itself flexibility over whether and how fast to conduct gilt sales when Bank Rate hits 1.0%, w when it unveiled its tightening strategy in August, the committee effectively pre-committed to a natural run-off when the policy rate hits 0.5%, barring exceptional circumstances.

Efficient market theory implies that if the market has understood the Bank's message, the gilt curve should already be fully factoring in the Bank's gradual run-down of its gilt stock through the natural run-off process. Tweaks to the run-off once it commences would serve only to cloud market perceptions of what is happening.

TRICKER QUESTION

The far trickier question is what assumptions market participants are, and should, make over the gilt sales when the policy rate hits 1.0%. One thing that will be key here is what impact balance sheet reduction is having, if any, on market curves.

Former MPC member Gertjan Vlieghe, highlighting how asset purchases had had a powerful impact in illiquid markets, argued that balance sheet reduction in liquid markets should have negligible effects. The MPC will want to see how the theory plays out in practice.

If quantitative tightening is not seen as a signal on rate policy, the signalling channel is ‘turned-off’ in the QE jargon. Then the committee could feel free to accelerate the pace of balance sheet reduction.

Potential inflation overshoots would be dealt with through Bank Rate hikes but if at some point balance sheet reduction does push up market rates, then policy rate hikes and quantitative tightening would become substitutes for each other.

MNI London Bureau | +44 203-586-2223 | david.robinson@marketnews.com
MNI London Bureau | +44 203-586-2223 | david.robinson@marketnews.com

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