As a new tightening tool comes into play the Bank of England could get a lot more inscrutable as it becomes known for its unpredictability.
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The process of unwinding years of the BOE's government bond buying could kick off if the BOE hikes rates to a key level at its next meeting in February. With the risk of Covid 19 restrictions threatening the economic outlook, traders are speculating on when and how the strategy will be introduced.
Recent dramatic market responses to decisions have indicated a shift from years of relative calm. Mollycoddling markets does not appear to be on the agenda of current Governor Andrew Bailey or Chief Economist Huw Pill.
Sanjay Raja, a U.K. economist at Deutsche Bank AG in London, said it was a meeting by meeting type outlook and that it was one of the few economists to call the decision of the BOE in December to raise rates.
The market is predicting the BOE's moves from its strategy report published in the summer. When its rate reaches 0.5%, the central bank said it would stop investing the proceeds of its maturing notes - reducing its portfolio automatically when the debt is due. It led to bets on a steeper gilt curve as longer-dated debt would bear the brunt of QT.
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Strategists from banks including Mizuho International Plc, Nomura International Plc and Deutsche Bank are predicting that the BOE will reach the key 0.5% level in February 2022, according to analysts. That would see a 28 billion-pound $37 billion redemption wiped off the central bank's books in March and mark the end of BOE interventions in the market for the foreseeable future.
The BOE's next step would mean a potential active sale of gilts after the rate reaches 1% a level that money markets see being hit in August.
Analysts are warning that the dent to the economy could be stymied if the U.K. government leaves the door open to further Covid 19 restrictions and cases close to record highs.
A decision to delay hiking rates until March raises the possibility that the BOE will do an interrupted reinvestment of the March redemption, according to Bank of America Corp. strategists Agne Stengeryte and Mark Capleton. The BOE could end up investing around six billion pounds before stopping with the bond maturing on March 7 and the next rate decision on 10 days later, they said.
They said that a failure to reach the 50 basis-point threshold by the February meeting does not rule out quantitative tightening starting in March.
There is still a question mark hanging over QT: no one knows how much tightening impact it could create and how the BOE will factor it in as part of its overall strategy over the next few years.
The BOE previously said that 60 billion pounds worth of bond buying is equivalent to around 50 basis points of cuts, but it isn't clear whether this approximation will stand in reverse. Peter Chatwell and Mizuho argue that the impact of stopping reinvestments will be limited. The active sale of gilts is another conundrum.
If QT doesn't go ahead in March, Net gilt issuance that month would tip into a negative territory of around minus 6.3 billion pounds, according to Bank of America calculations. Gilt investors have been struggling with a lack of paper since the U.K. s debt management office slashed issuance for the fiscal year in October.
The diversity of options for the BOE is not only causing unasiness among gilt investors but also among international bodies. The International Monetary Fund stressed the importance of improving the predictability of the QT strategy to avoid markets second guessing. How can I run a business with friends without killing the friendship?
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