Bank of England bond sales blamed for cash shortage

Unlock Editor’s Digest for free

The Bank of England’s big sell-off of government bonds is causing a cash crunch in the corners of money markets and may need to end, investors have warned.

Over the past two years, the Bank of England has reduced its balance sheet from nearly £1 trillion to around £760 billion, largely by reducing its holdings of government debt it bought under numerous rounds of quantitative easing stimulus.

Unlike other central banks, the Bank of England doesn’t just wait for bonds to mature, it actively sells them.

Under QE, the Bank of England created money to buy government bonds. By reversing course, it allows bonds to mature without replacing them, while it sells others to investors and the money it receives is destroyed, in a process known as quantitative tightening that is draining the liquidity that has flooded markets in recent years.

As a result, there have been surges in short-term lending markets and investors are rushing to take advantage of a special Bank of England facility that allows them to borrow cash against government bond guarantees.

Last week, investors borrowed £16bn from this Bank of England short-term repo facility, which was set up in 2022 to help borrowers (mainly banks) access short-term cash. This is a sharp rise from less than £5 billion at the beginning of last month.

The cash shortage, which also prompted a recent rise in repo rates, could cause the Bank of England to slow the process of reducing its balance sheet when it reviews its policy in September, according to analysts at Barclays, Bank of America and NatWest.

“When you look under the hood, there are a lot of little things that point to something a little deeper. . . all of which points to friction beginning to appear in the market,” said Barclays strategist Moyeen Islam. “It wasn’t supposed to happen” so early in the process of liquidating the Bank of England’s bond portfolio, he added.

Bank of England Governor Andrew Bailey said last week that the adoption of the repo facility was “encouraging” and that he expects a “significant increase” in its use. His estimate for the “steady state” balance sheet is between £345bn and £490bn.

However, analysts believe that the real, stable size of the central bank’s balance sheet that allows money markets to function well could be considerably larger. A rise in money market lending rates could potentially reduce the effectiveness of the Bank of England’s monetary policy at a time when it is expected to begin cutting interest rates.

(%) line chart showing that money market rates have risen

Mark Capleton, a strategist at Bank of America, said the Bank of England is “progressing quite quickly towards this uncertain ceiling,” and added that he believes the Bank of England is likely to stop active sales of government bonds starting in September. , partly due to the large volume of government bonds owned by the BoE maturing next year.

The rush of demand for the Bank of England’s repo facility comes as market rates indicate conditions have tightened. The rate banks pay to borrow sterling overnight, known as Sonia, has risen slightly this year and is now at 5.2 per cent, just below the bank’s base rate of 5.25 per cent. .

Ronia, the measure of the overnight interest rate that banks pay each other to borrow sterling against collateral, rose rapidly in late April to be 0.15 percentage points above the bank rate. The rate has since returned to more normal levels.

A longer rise in interest rates in repo markets (in which investors exchange bonds for short-term loans) could cause the Bank of England to slow the pace of QT, said Tomasz Wieladek, chief economist for Europe by T Rowe Price.

Leave a Comment