The Bank of England has begun shrinking its £838 billion holdings of government bonds in a bid to reduce the central bank’s emergency stimulus to the economy and fend off claims that it has lost its independence by financing government borrowing directly.
Ahead of Thursday’s meeting when the Bank is expected to raise its base rate by one percentage point to 3.25%, officials offloaded £750m of government bonds, known as gilts, to commercial banks and insurers as part of a plan to sell £80bn by the end of next year.
The move marks a major turning point at Britain’s central bank, which is seeking to raise borrowing costs to lower inflation, which hit 10.1% in September.
Despite concerns that the UK government had tarnished London’s reputation last month as a haven for investors, the sell-off was oversubscribed and boosted the gilt market, pushing interest rates on the benchmark five-year bond down 0.04% to 3.56%.
Governor Andrew Bailey postponed the sale following Liz Truss’s mini-budget, which sparked panic in financial markets, depressed demand from investors for UK loans and sent interest rates on five-year bonds above 5%.
Mortgage lenders have responded by raising mortgage rates above 6% on two-year fixed deals, leaving many homebuyers facing thousands of pounds a year in higher annual payments.
The national debt is more than £2tn, owed to a combination of foreign investors, pension funds and the Bank of England. Since 2008, the government has relied on Threadneedle Street to act during periods of crisis as a buyer of last resort.
Under a program called quantitative easing (QE), the Bank has been buying increasing amounts of government debt that will peak at £875bn in 2020.
In the budget later this month, the government is expected to announce that it needs about £170bn of extra borrowing to finance energy price caps, higher interest bills and to cope with a possible recession next year.
Last week Sir Robert Stheeman, chief executive of the Debt Management Office, which arranges the gold sale, said: “The market is obviously volatile, it’s depressed, and I don’t think we should pretend otherwise,” adding that volatility had been triggered. by UK-specific factors.
“We don’t want to be the little wildling that strays too far from the pack, but if we can get back into the pack, and if we can be seen as something exceptional, that’s obviously important.”
Bailey is the first boss of a major central bank to actively sell bonds on the open market. The US Federal Reserve has so far opted not to buy back short-term loans when they mature as it seeks to scale back its £9tn QE hike.
On the other hand, most gilts have long maturities and therefore it will take years to reduce the stock by allowing loans to mature.
Analysts say allowing the auction to go ahead is a sign of confidence that the market is calm and able to absorb the additional bonds.
Some international agencies fear that a sharp increase in borrowing costs by the Fed, the European Central bank and the Bank of England through a combination of higher interest rates and the reversal of QE, dubbed quantitative tightening, will push the global economy into recession. next year.
The International Monetary Fund has called on central banks to coordinate their plans to issue cheap credit to minimize the impact on economic growth.
The World Bank has warned that a rapid move to higher interest rates will hit many developing economies without giving them time to find funds to pay higher debt bills.
Many have taken out huge loans to tackle poverty and issues related to climate change.
The IMF said it is concerned that the number of countries seeking financial support has increased sharply since the pandemic and that financial issues are likely to worsen if interest rates continue to rise.