Quick View: Bank of England – Do no harm
Jenna Barnard reflects on the Bank of England’s September policy decision which appears designed to inflict no further negative surprises on a fragile gilt market.
2 minute read
Key takeaways:
- The Bank of England (BoE) held rates at 4% as the market anticipated, but the real interest was the widely expected decision to slow the annual shrinking of the balance sheet from £100bn to £70bn.
- Stubborn inflation in the UK is staying the BoE’s hand and comes against a backdrop of concerns about heavy borrowing from the UK government that is putting upward pressure on gilt yields.
- The decision on quantitative tightening was in line with market expectations. The BoE appears keen to inflict no further negative surprise on a fragile government bond market.
Having squeaked through a cut in interest rates to 4% at the their 7th August meeting with a tight 5-4 vote, the market has priced out additional interest rate cuts this year from the Bank of England (BoE) and Gilts have continued to underperform their US counterparts. Indeed, UK activity data since last month’s meeting has been resilient with employment, in particular, showing stabilisation whilst inflation remains far too high for comfort both on a headline and core basis and increasingly divergent versus the rest of the developed world. The economic fundamentals underpinning the UK government bond market do look materially trickier than many other developed economies as a result of this higher inflation backdrop: no longer the laggard in disinflation because the UK is increasingly looking like a structural outlier.
As a result, the September policy meeting was never about rate cuts but rather the decision around quantitative tightening (QT) – the amount and the skew towards long dated bonds. Long dated government bonds traded very poorly through August into early September. The extreme fragility of this part of the Gilt market resulted in further Debt Management Office (DMO) intervention in early September with the announcement of the cancellation of a long bond which had been scheduled for December 2025. The DMO has responded aggressively to the lack of demand for long dated Gilts by skewing issuance away from this part of the yield curve. The question going into the BoE meeting was whether they would respond too?
Given the fragility of the Gilt market, the BoE appears to have stuck as close as possible to market consensus expectations for fear of causing further volatility: £70 billion in total QT and continuing to underweight long bond sales “to better reflect demand conditions” at 20% of total sales. The Gilt market reaction has been predictably muted as a result. This is a central bank that really does not want to cause any surprises for a fragile bond market.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
Debt Management Office (DMO): An agency of HM Treasury in the UK, responsible for the debt and cash management of the UK government.
Fiscal/Fiscal policy: Describes government policy relating to setting tax rates and spending levels. Fiscal deficit represents the gap between government revenues and spending. A deficit implies that state sector spending exceeds the revenues collected in a given year.
Gilt: A bond issued by the UK Government. Their name derives from the fact that early forms of the bonds were issued as certificates with gilt-edges.
Inflation: The rate at which prices of goods and services are rising in the economy. Core Inflation are price indices that exclude volatile items, typically food and energy.
Issuance: The act of making bonds available to investors by the borrowing (issuing) company, typically through a sale of bonds to the public or financial institutions.
Maturity: The maturity date of a bond is when the principal investment (and any final income payment) is paid to investors. Shorter-dated bonds generally mature within five years, medium-term bonds within five to 10 years, and longer-dated bonds after 10+ years.
Monetary policy: The policies of a central bank, aimed at influencing the level of inflation and growth in an economy. Monetary policy tools include setting interest rates and controlling the supply of money.
Quantitative tightening: A monetary policy tool used by central banks to decrease the money supply by either selling government securities, or letting then mature and removing them from its cash balances.
Yield: The level of income on a security over a set period, typically expressed as a percentage rate.
Yield curve: A graph that plots the yields of government bonds against their maturities. Normally, the yield curve is upward sloping, where yields for shorter-maturity bonds are lower than yields for bonds with a longer maturity.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
There is no guarantee that past trends will continue, or forecasts will be realised.
Marketing Communication.
2 minute read
Key takeaways:
- The Bank of England (BoE) held rates at 4% as the market anticipated, but the real interest was the widely expected decision to slow the annual shrinking of the balance sheet from £100bn to £70bn.
- Stubborn inflation in the UK is staying the BoE’s hand and comes against a backdrop of concerns about heavy borrowing from the UK government that is putting upward pressure on gilt yields.
- The decision on quantitative tightening was in line with market expectations. The BoE appears keen to inflict no further negative surprise on a fragile government bond market.