The Bank of England is selling bonds really quickly, and this is making investors feel like they’re in a situation similar to selling gold when its value is very low. Christopher Mahon, who works at Columbia Threadneedle, pointed this out.
After the 2008 financial crisis, for 13 years, the Bank of England bought a lot of U.K. government bonds (known as gilts), totaling £895 billion ($1.12 trillion). They did this when interest rates were very low.
Now, even though the value of these bonds has dropped a lot, the Bank of England is selling them rapidly.
Central banks, the Bank of England, is being the most forceful in getting rid of these bonds, which they had originally bought to help the economy during the time of quantitative easing, as Mahon mentioned.
Selling bonds on such a large scale like this has never been done before. What’s unique is that it’s happening when bond markets are dealing with both high inflation and big increases in interest rates. Mahon talked about this in a recent video blog.
Bank of England’s Aggressive Gilt Sales
The Bank of England is incurring substantial losses as a consequence of these sales, with the U.K. The Treasury provides a safety net. In late July, the central bank estimated that the Treasury would need to guarantee £150 billion ($189 billion) of losses related to its asset purchase facility (APF).
“Our analysis indicates that this reduction is roughly equivalent to approximately 7.5% of the entire outstanding government debt,” Mahon commented. “This represents a significant amount and essentially amounts to additional issuance that the market has had to absorb.
Yields on the benchmark 10-year U.K. gilts have surged from approximately 2.99% in early February to reach a 13-year peak of nearly 4.75% in mid-August, before experiencing a slight moderation. It’s important to note that yields move in the opposite direction to bond prices.
According to Columbia Threadneedle’s analysis, the pace of bond sales is 70% faster than that of the U.S. Federal Reserve and roughly double the rate of the European Central Bank.
“It remains unclear to us why the Bank of England has been so expeditious in its approach. The rapid pace of these sales has been exerting downward pressure on gilt prices, exacerbating losses for taxpayers, and, most importantly, it has transformed what would have been potential paper losses into a real financial burden for the U.K. The Treasury must address,” remarked Mahon.
“In our perspective, the substantial selling pressure exerted by the U.K. central bank at this rapid rate is among the reasons why gilts have faced challenges this year and encountered difficulties in attracting buyers in the market.”
Is There an Investment Potential?
The United Kingdom undeniably has a history of uncertainty when it comes to large-scale asset divestments.
During the years 1999 to 2002, the U.K. controversially sold 401 metric tons of gold, a significant portion of its total holding of 715 tonnes, at a time that ultimately proved to be the low point for the precious metal market.
According to Mahon, there are evident parallels in the way the Bank of England is currently divesting its gilt holdings.
“Comparable advance notices of sales are employed, leading to price depreciation. The Bank of England’s apparent lack of concern about the prices obtained or the magnitude of the incurred losses is also reminiscent. Moreover, there is a significant market concern that the pace of these sales might intensify,” he commented.
“In our assessment, the Bank of England’s actions could once more signify the market’s lowest point.”
Mahon further noted that as inflation recedes and the prospect of peak interest rates looms, this could present an opening for investors. He stated, “This is among the factors why we believe gilts, as well as fixed-income assets, are currently priced very attractively.”
The Monetary Policy Committee of the central bank is scheduled for its next session on September 21. During the previous meeting, the committee did not divulge any additional details regarding its intentions for gilt sales. However, in July, Deputy Governor Dave Ramsden hinted at the possibility of an acceleration in quantitative tightening.
In a research, memo released last month, BNP Paribas economists forecasted that the central bank might boost the rate of gilt sales from £80 billion annually to £95 billion.
The Bank of England, on its part, contests that the asset sales are significantly impacting the markets. In his July address, Ramsden stated that an analysis of the available evidence suggested that the effects of “quantitative tightening” (QT) on gilt yields, while not nonexistent, seem to be notably smaller in magnitude than the effects of “quantitative easing” (QE).
He went on to say, “Based on our experiences thus far, as a very approximate estimate, Bank staff believe that an additional one-time £80 billion of QT compared to expectations is likely to result in an increase of less than 10 basis points in 10-year gilt yields under prevailing market conditions.”
The Bank of England’s fast bond-selling approach is worrying investors, similar to past asset sales. Although it’s causing losses and higher gilt yields due to inflation and interest rate uncertainties, some investors see opportunities. The next Monetary Policy Committee meeting could reveal more about the central bank’s strategy.