The Bank of England's programme of gilt sales, along with a government indemnity to cover losses, are raising questions. Is the central bank pushing yields higher? And should the indemnity be changed?   

In January 2009, then chancellor Alistair Darling announced that the Bank of England could buy assets to stave off a depression following the credit crunch. What followed is history – not least for defined benefit sponsors and funds, who saw deficits balloon, while interest rates were cut from 5% to 0.5% in less than six months.  

QE became normalised for societies in the UK and elsewhere, reaching stratospheric levels during the Covid-19 pandemic in 2021, when it peaked at £895bn in the UK.  

That same year, a decision was taken. The Monetary Policy Committee voted to reduce the stock of gilts held in the Asset Purchase Facility by £80bn in 2022-23 and and £100bn in 2023-24  – targets that could not be achieved by passive run-off alone given the relatively long maturity of gilts held in the APF portfolio, longer than those the Federal Reserve or European Central Bank bought.  

On 1 November 2022 – delayed by the LDI ‘interlude’ – the Bank of England began to actively sell some of its large holdings of UK government debt, in what is sometimes called ‘quantitative tightening’. It is not the only central bank to sell bonds purchased under QE; Sweden’s Riksbank has been selling government bonds via auction since April last year, and the Reserve Bank of New Zealand is selling NZ$5bn a year to New Zealand Debt Management.   

However, the BoE’s sell-off has been criticised for costing taxpayers and affecting markets.   

In its June 2022 Market Participants Survey, the Bank of England said the median respondent reported that QT expectations had pushed up yields by 10bps for the UK 10-year gilts, and though it admits that QT is having some tightening effect on yields, says this is small.  

Last year, it wrote that “the impact of QT on financial markets, while difficult to measure precisely, is judged to have been small”. 

The 10-year gilt yield increased by around 275bps between February 2022 and June 2024 with the term premium estimated by the Bank of England to have risen by around 75bps. For the Bank, the APF reduction accounts for only around 10–20bps, with 10bps as a central case, of the total rise in the term premium, with the rest down to other factors. 

 

Christopher Mahon, head of dynamic real return at asset manager Columbia Threadneedle, is unconvinced. The Bank of England’s programme of gilt sales has raised yields by about 40 basis points, he claims. 

“If they didn’t do active QT, it would save 40bps interest cost a year, £1bn this year alone,” he says. 

He argues the Bank’s way of assessing how QT affects markets – in part by looking at whether there are dysfunctions on auction days – is too narrow. 

“That’s not where you’d see the issue. In functional markets, you’d just see the issue in lower prices,” he says. “There are very, very few markets where you can sell £50bn or so a year and not affect the price level.” 

The Monetary Policy Committee is not sufficiently curious about these issues, he maintains. He wants it to be open to alternative options should QE ever be used again, such as only buying at the front end of the curve. 

How QE was executed is part of the reason for the losses now incurred, he argues, adding that buying longer maturities meant taking a view, even if the Bank bought the index: “The UK has the longest maturity government bond market of any major country, so buying the index means choosing to do something different to most major countries.”  

At the shorter end, mortgages and corporate borrowers are found, rather than pension funds, he notes.  

Others also think that the Bank is influencing the market with the sales. David Rae, head of strategic client solutions at Russell Investments, says gilt pricing is about overall supply and demand, so if the Bank is selling, this will contribute to falling prices.   

One feature of the sterling market is “a real separation between short-term rates driven mainly by monetary policy and then long-dated rates driven by supply and demand”, notably from long-term asset owners, he explains.  

With yields up since the Bank bought the gilts, and prices lower, this has crystallised losses. The Office for Budget Responsibility estimates the cumulative lifetime cost of the APF is a net loss of £104.2bn, although this figure is highly uncertain – it’s a central scenario between a £46.6bn and a £156.9bn loss, depending on whether interest rates fall or rise.  

The Bank asserts that it does not consider financial risk or profit when making monetary policy. It does not need to, because the losses do not end up on its own balance sheet: under a 2018 memorandum of understanding with the government, the Treasury immediately compensates the Bank, and the Bank pays the Treasury if it makes a profit on the AFP. Until July 2022, the AFP transferred £123.8bn to the Treasury, but cash flows started to reverse in the third quarter of 2022. In 2023-23, the Treasury transferred £44.5bn. 

Mahon believes the Bank has lost 5% of GDP on QE, more than three times as much as the Federal Reserve, “yet there is very little examination of why that is the case, how it came about, [and] what options it has in the future”.  

Most of these losses are now locked in as gilts are sold at today’s interest rate profile. Still, he says scaling back active QT “will have some small benefit for the taxpayer”. This is because the sale “depresses the price of gilts [and] puts up the interest cost the government has to pay in the meantime”, according to Mahon. 

Russell’s Rae thinks the change of government in the UK could be a catalyst for revisiting how the government indemnity works by changing the timing of the payment from the Treasury to the Bank.   

In other countries, losses “sit there” as a liability to the treasury, he says. A new government could bring this change in pointing to practice elsewhere to justify the move.  

Storing up liabilities in this way would constitute a generational transfer, but Rae argues that in theory, this storing could last in perpetuity. However, “the Bank of England is probably quite comfortable with the status quo", he adds.  

Politicians have not been oblivious to the fact huge sums are changing hands between the Bank of England and the Treasury. The Treasury Select Committee conducted an inquiry into quantitative tightening last year, probing the bank on its decisions and the fact taxpayers are now compensating the Bank for losses made on trades that it openly admits are conducted without taking risk or profit into account.  

The Treasury itself has defended the Bank, saying that changing how the pile of gilts is reduced would not alter the effect of doing so.   

“There is little evidence that a different pace of sales would reduce cashflows between HMT and the [asset purchase facility] or achieve better value for money,” it argued, and that “all else equal, holding gilts for longer is unlikely to avoid these losses. Instead a higher net interest cost is incurred from holding the portfolio for longer.”  

Pointing out that cash had been flowing the other way until 2022, the government stressed the importance of the bank being seen to be free from interference by the Treasury.  

“Independent monetary policy is essential for macroeconomic credibility, and therefore beneficial for the economy and public finances,” it wrote.  

The Bank itself suggested that looking at QE’s fiscal impact only in terms of recent cashflows from the Treasury misses the bigger picture. Apart from money having been paid into government coffers in the years leading up to 2022, a net £74bn, it said QE had “reduced borrowing costs, lowered unemployment, supported the economy and helped stem disinflationary pressures at various points over the past 15 years”.  

Despite these stated benefits, the Bank is now developing a new backstop facility to reduce the risk of having to resort to gilt purchases in future – something it also had to do to prevent a downward spiral in gilt markets prompted by the 2022 ‘mini Budget’. Under this new facility, the Bank will lend cash in exchange for gilts to eligible insurance companies and pension funds, including associated liability-driven investment funds.  

What do you think – how has QT shaped bond markets? And should the government change the indemnity?