Explanation: Why does the Bank of England sell government bonds? | Techy Kings

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LONDON, Nov 1 (Reuters) – The Bank of England passed a key milestone on Tuesday when it held its first auction to sell some of the 875 billion pounds ($1.01 trillion) of government bonds it bought during its successive quantitative easing (QE) program from 2009- 2021.

Britain’s central bank is the first in the Group of Seven rich nations to actively sell QE bonds to investors.

It has been reducing its holdings of British government bonds, known as gilts, bought under QE since February, when the BoE said it would no longer buy new gilts to replace maturing ones. Total holdings have since fallen to 838 billion pounds.

The US Federal Reserve and the Bank of Canada have adopted similar policies, sometimes known as passive quantitative tightening (QT), to help unwind bonds built up over years of stimulus to support crisis-hit economies.

WHAT IS BOE DOING NOW?

The BoE sold 750 million pounds of British government bonds with remaining maturities of three to seven years at its first gold auction on Tuesday, receiving strong demand from investors.

In August, the BoE said it wanted to reduce its total gold holdings by 80 billion pounds over a 12-month period starting at the end of September. To achieve this, it said it would have to sell about 10 billion pounds of gilts every three months, without reinvesting the proceeds of maturing bonds.

The start of the sell-off was delayed first by the postponement of September’s Monetary Policy Committee meeting after Queen Elizabeth’s death, and then by a chaotic sell-off in gilts triggered by Prime Minister Liz Truss’ plans for unfunded tax cuts.

Market turmoil forced the BoE to step in and buy 19 billion pounds of long-dated and inflation-linked gold in an emergency program that runs until Oct. 14.

The BoE will now hold eight gilt auctions this year, totaling 6 billion pounds of sales and including gilts with maturities of up to 20 years.

It originally aimed to sell 8.7 billion pounds of gilts this year, including some with maturities of more than 20 years – the kind worst hit by the fire sale of assets by pension funds following the Truss government’s “mini budget” on September 23.

The BoE said it still intends to reduce its gold holdings by the 80 billion pounds it announced in August. Policymakers will review sales rates annually.

WHY IS BOE SELLING GILTS?

British government bonds have a longer average maturity than those issued by other countries, so the BoE needs to sell gilts to achieve the same rate of balance sheet reduction that other central banks would get by simply letting their bonds mature.

More broadly, QE is always meant to be temporary and Governor Andrew Bailey has been keen to reverse some of the purchases, particularly after the BoE’s gold holdings doubled during a wave of QE purchases in the COVID-19 pandemic.

At its peak in December 2021, the BoE will own around half of all conventional British government bonds in issue.

The BoE does not intend to reverse QE completely, as regulatory changes since the 2008 financial crisis mean banks have to hold more cash than before. It does not set long-term targets for gold holdings.

Reversing QE can help fight inflation, as it increases borrowing costs and reduces government, business and public money to spend on other things.

However, the BoE says raising interest rates is its main tool to control inflation, as its effects are better understood than QT.

WHAT IS THE EFFECT OF SELLING GILTS?

The BoE expects QT to have a relatively small impact on gold prices and borrowing costs.

It sees the effects of QE and QT as highly dependent on financial market conditions – pushing borrowing costs up or down significantly if carried out at scale during market turmoil, but having little effect if carried out gradually during calm markets.

The BoE’s 6 billion pounds of sales came alongside 37 billion pounds of gold issued by the government over the same period.

Bond strategists have questioned how strong demand is, as gold prices have slumped this year, and some investors have suggested the central bank would be wiser to delay sales until 2023.

Strategists at Citi noted that long-dated gold prices rose against shorter-dated gold prices after the BoE announced on October 18 that it would exclude them from its purchases this year.

The overall past effects of QE on the economy are difficult to measure, and it is very difficult to separate the effects of actions by the BoE from spillovers from bond purchases by the Fed and the European Central Bank.

In general terms, QE pushes up the cost of borrowing in the medium or long term, raises inflation slightly and may lead to relatively low unemployment and faster growth than otherwise.

The BoE also emphasized the need for QE to stabilize markets at the onset of the COVID-19 pandemic.

Critics say QE played a major role in driving up house prices and the stock market for more than a decade, exacerbating inequality. The BoE has said that without QE, consumer price inflation will exceed its 2% target in the 2010s, and unemployment will be even higher.

($1 = 0.8671 pounds)

Report by David Milliken; Editing by Catherine Evans

Our Standards: Thomson Reuters Trust Principles.

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