The Bank of England will hold on to its 375 billion pounds ($630 billion) of U.K. government bonds until at least 2017 as officials maintain stimulus to underpin the recovery, according to Pacific Investment Management Co.
Quantitative easing, the asset-purchase program designed to keep borrowing costs low and stimulate the economy, has left the London-based central bank with more than a quarter of the value of gilts outstanding. While BOE officials say they won’t consider selling bonds until they’ve lifted the benchmark rate from a record-low 0.5 percent, an improving economy has pushed up short-dated yields and fueled speculation about how and when the stimulus might be removed.
One option, suggested by Governor Mark Carney last month, is to refrain from reinvesting the money from maturing bonds. Gilts with a face value of about 23.9 billion pounds are set to be redeemed from the BOE in 2015, followed by 19 billion pounds in each of the following two years, according to BOE data.
“If and when the bank has succeeded in taking the policy rate up to say 1.5 percent to 2 percent, it is quite possible they stop reinvesting the proceeds from maturing gilts,” Michael Amey, a London-based money manager at Pimco, which oversees the world’s biggest bond fund, said yesterday. “It’s unlikely that the bank would take a more proactive approach.”
One-month forward Sonia contracts signal the central bank will boost the key lending rate by 25 basis points by next April. They show the rate reaching 1 percent four months later, 1.5 percent by March 2016 and 2 percent by that November.
“The bank has been very clear about the sequencing of any asset unwind, saying it will be rates first,” said Moyeen Islam, a London-based fixed-income strategist at Barclays Plc. “It will be a multi year process. The bank is quite relaxed about it.”
Speculation the first rate increase could come as early as the fourth quarter of this year has pushed up yields on gilts maturing in less than five years. The additional yield investors demand to hold 10-year gilts over their two-year counterparts has fallen 48 basis points, or almost half a percentage point, to 197 basis points this year.
Ten-year gilt yields, which were 2.68 percent at 3:19 p.m. London time, don’t offer value to investors because the economy is strengthening, Islam said. The rate will increase to 3.5 percent by year-end, he predicted. The yield, which is 116 basis points higher than its German equivalent, will be at 3.3 percent by the end of the fourth quarter, the median of 23 forecasts compiled by Bloomberg show.
Another factor that’s key to the BOE’s decision is the amount of bonds the Debt Management Office has to sell in any year, Amey and Islam said. With the DMO projecting a financing requirement of 118 billion pounds in the fiscal year starting April 2017, bank officials will want to avoid a clash, Amey said.
Policy makers last increased their bond-buying target in July 2012. The Monetary Policy Committee voted 9-0 to maintain the stock of purchased assets this month, minutes of the April 9 meeting showed yesterday. That’s in line with their stated intention to leave QE unchanged at least until the first increase in its key rate.
Carney has ruled out selling the BOE’s gilt holdings in full and says any divestment should only begin after the benchmark rate has been increased several times.
“We need a predictable schedule, in my opinion, for rolling off our gilt portfolio when the time comes,” he told Parliament’s Treasury Committee in London last month. “One option is not to reinvest as those gilts matured.”