Gilts Set for QE Redux as BOE Prepares to Reinvest $50 Billion

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The Bank of England has about 32 billion pounds ($50 billion) of government bonds maturing in the coming months, and its plan to reinvest the proceeds may boost longer-dated debt the most.

That’s the view of Nomura Holdings Inc., which likened the prospect to a round of the quantitative-easing program under which the central bank acquired the securities in the first place. The Treasury is due to repay the debt between September and January.

“The redemptions should be supportive of the gilt market, the long end in particular and especially the 20 year,” said Andy Chaytor, head of European rates strategy at Nomura in London. “We’re looking for 20 years to outperform on the curve.”

U.K. debt has underperformed German bunds as the risks of a Greek exit from the euro region diminished and BOE Governor Mark Carney warned that the end of record-low interest rates in Britain was in sight. Gilts have lost 1.5 percent since their recent peak on July 7. Bunds are little changed.

While the prospect of higher borrowing costs weighs on shorter-dated debt, long-dated gilts are being underpinned by retirement funds seeking the predictable revenue stream of fixed-income securities.

Strong Demand

The extra yield investors demand to hold 20-year gilts over those due in 10 years was 56 basis points in London on Friday, in line with a year-to-date average of 55 basis points. The spread between the two has narrowed from 61 basis points on July 7. It was as low as 48 basis points on January, the least since September 2014.

The BOE has held its benchmark interest rate at 0.5 percent since March 2009, when it also began its QE program in an attempt to shore up the British economy amid the global credit crisis.

In the last round of purchases, in 2012, the BOE acquired 50 billion pounds of gilts. It holds 375 billion pounds of the securities in total and officials have ruled out any unwinding until the key rate has risen materially. That’s because they want the option of cutting borrowing costs again if needed.

With forward contracts barely pricing in a half-point rate increase by September next year, economists say there is little prospect the BOE will cease reinvesting the proceeds of maturing gilts before 2017.

BOE buying could add to seasonal gains for gilts in the third quarter. The 10-year yield has declined between July and September in seven out of the last nine years, according to data compiled by Bloomberg.

It dropped for a third day on Friday to 1.98 percent, extending its fall this month to 5 basis points. The 20-year yield has posted a similar decline. Two-year yields are up 8 basis points.

“For the long end in particular there is quite a lot of demand,” said John Wraith, head of U.K. rates strategy at UBS Group AG in London. “That is where you will see the biggest potential reaction.”

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