Last week was a landmark week for the Bank of England. After holding rates steady since the financial crisis, the central bank’s monetary policy committee decided to cut interest rates by 0.25% and promised to cut rates further — probably to 0.1% — in an attempt to kickstart the UK’s stuttering economy.
Along with the 25 basis point bank rate cut, the BoE is also planning to ease through £60 billion of additional gilt QE — taking the total value of QE since the financial crisis to £435 billion – £10 billion worth of corporate bond purchases and £100 billion via the introduction of a new Term Funding Scheme, which is designed to pass on the bank rate cut to borrowers.
In essence, the BoE has thrown the kitchen sink at the UK’s financial system in an attempt to stave off any Brexit inspired economic turbulence.
However, according to HSBC’s analysis, gilt investors won’t initially benefit from the BoE’s new bond-buying program. The gilt purchases begin today (August 8) and are expected to last for six months. Similar to previous rounds of QE, the 70% ceiling on free float remains and the program does not include linkers.
The UK’s low yields may not last
According to HSBC’s research, in the past QE announcements have marked the low level of yield in the medium term for treasuries and gilts and this time around the bank’s analysts don’t expect this trend to break. Indeed, HSBC’s report on the BoE bazooka states that “our inclination is not to chase the market and to sit back with a mildly bearish stance.”
The report goes on:
“Experience from previous episodes of quantitative easing suggests the knee-jerk reaction to lower yields does not follow through. The announcement of the first QE in March 2009 resulted in a sharp drop in yields on the day but it took years before the gilt yields made a sustained move below levels reached on the announcement. The second round of QE saw the low for yields reached at the end of the purchase period in 2012 but yields subsequently increased through 2013; the big move then was led by the US taper tantrum. Regarding linkers, a flattening of the break-even curve may persist as front and long-ends are pulled in opposite directions. The possibility of higher near-term inflation is supportive for wider front-end BEs whereas low nominal yields and the beta-effect pulls long-end BEs lower.” — HSBC
This may not be the last of the BoE’s dovish actions this year. The UK’s new Chancellor is yet to put forward a new fiscal plan for the country following Brexit and it’s widely believed that the autumn statement will include promises of higher spending and less budget cuts. A fiscal stimulus may also be proposed, which would materially drive up gilt supply next year and the BoE may step in to improve market conditions further (via more QE).