The Bank of England faces a pivotal decision this week concerning its approach to quantitative tightening (QT), a process that involves reducing its holdings of government bonds, or gilts, amid rising inflation and volatile bond markets. While a change in interest rates is not expected at Thursday’s monetary policy committee (MPC) meeting, the approach to managing the central bank’s balance sheet could have significant implications for government borrowing costs and financial markets.
Inflation figures due Wednesday are anticipated to show a rise above 3 percent, up from 2.9 percent, and July’s gross domestic product, which expanded by 0.4 percent, adds further context for policymakers. Despite some MPC members having voted for a rate hike in the previous meeting, the consensus leans toward holding the current Bank rate at 3.75 percent for the remainder of the year.
The central issue centers on the pace and scope of QT, a process that began in 2022 after the Bank transitioned from quantitative easing (QE), which had been in effect from 2009 to 2021. During QE, the Bank created money to purchase gilts and corporate bonds, peaking at £895 billion in assets, equivalent to about 35 percent of the UK’s GDP and over a third of government debt. This approach effectively lowered borrowing costs for the government by keeping interest rates low and recycling gilt coupon payments back to the Treasury.
Since 2022, the Bank has sought to reduce its balance sheet through both passive QT—allowing maturing gilts to roll off without reinvestment—and active QT, involving outright sales of gilts back into the market. The Bank of England stands out among major central banks for engaging in active sales, which have amounted to around £129 billion of gilts out of £350 billion reduced since October 2022. Including corporate bonds, active sales represent approximately 40 percent of the total quantitative tightening.
The reversal from QE to QT has led to financial costs for the government. Rising interest rates have meant the Bank now pays more in interest on reserves held by commercial banks than it earns on its gilt holdings. Additionally, selling bonds purchased at lower yields in the past has caused valuation losses. The Office for Budget Responsibility has projected that transfers from the Treasury to the Bank, primarily due to these losses, could total £145 billion between 2024-25 and 2029-30. The Treasury has estimated the overall lifetime cost of QE and QT at around £133.7 billion.
The timing of QT is complicated by soaring gilt yields, which have neared multi-decade highs. Current ten-year gilt yields hover around 5.35 percent, the highest since 2007, while 30-year yields exceed 5.9 percent, reaching levels last seen in 1998. This rise in yields increases government borrowing costs and raises concerns over the impact of continued gilt sales by the Bank.
Most analysts agree that QT has contributed to these higher yields, though estimations differ. The Bank suggests the effect has added about 20 to 30 basis points to ten-year yields since 2022, while external estimates have placed the impact higher, with some figures ranging from 44 to 70 basis points due to active sales.
Ahead of the MPC meeting, former member Michael Saunders has recommended a gradual slowdown in QT, proposing a reduction in gilt sales to a target of £50 billion over the next 12 months, down from £70 billion currently and the original £100 billion annual pace. He also advocates for transferring management of the Bank’s reserve operations from the MPC to the Bank’s executive to better reflect their technical nature.
Despite calls from some quarters to halt QT altogether given the current gilt yield environment, the Bank has indicated that an abrupt pause could unsettle markets and exacerbate concerns about fiscal dominance over monetary policy. As such, it appears likely that the Bank will continue QT in a measured and predictable manner, balancing its inflation-fighting responsibilities with the financial market challenges posed by rising government bond yields.