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Thought UK quantitative easing was over? Not quite

The Bank of England stopped the money-printing presses three years ago but will soon have £17 billion to plough into government bonds.

 
Thought UK quantitative easing was over? Not quite

While all the talk at the Bank of England is over when to hike interest rates, investors should not ignore the opposite effect that its quantitative easing (QE) programme is continuing to exert on monetary policy.

It's now more than three years since the Bank performed its last bout of QE, printing £50 billion of new money to buy bonds in July 2012. That took the total amount of QE funds since the financial crisis to £375 billion.

While that total figure has remained unchanged, it doesn't mean the QE money has been sitting idle. When the bonds the Bank has bought have matured, that cash has been reinvested in other fixed income stocks.

That's exactly what the Bank will have to do in just over a week's time, when £38 billion of UK gilts will mature. The Bank owns just under half of these bonds bought through the QE programme, meaning it will need to find a new home for £17 billion on 7 September.

On the face of it, this does not seem like it would have an 'easing' effect: the Bank isn't buying any more bonds, just replacing those it no longer owns. But Matthew Russell, manager of the M&G Gilt & Fixed Interest fund, argued it could have a stimulative impact.

'In my view, this is the equivalent to an easing of monetary policy,' he said. 'This is because the average duration of the Bank of England's gilt holdings [ie, their sensitivity to interest rate rises] will increase, and therefore the £17 billion reinvestment in gilts will have a larger (downward) effect on gilt yields than it currently does today.'

The flood of cash from maturing bonds comes as the Bank of England – and its US counterpart, the Federal Reserve -–are under pressure to delay their first rise in interest rates since slashing the cost of borrowing to near zero after the 2008 financial crisis. Reinvesting the money in gilts will be the equivalent of a small cut in long-term interest rates, Russell explained.

'All else being equal, an inflow of £17 billion into the gilt market will clearly put downward pressure on yields [which move in the opposite direction to bond prices] along the length of the curve – and that doesn't even take into account the other £21 billion that private investors will have to find a home for.'

Gilt market speculates

Gilt investors are already speculating over which areas of the bond market are likely to benefit from this £17 billion inflow of Bank of England money, said Russell.

The Bank of England has already outlined rules over how it reinvests QE money into gilts: it will split funds equally between three 'buckets' – bonds that mature in the next three to seven years, those maturing over seven to 15 years, and gilts with a maturity of more than 15 years.

Russell said that as there were fewer bonds in the 7-15 year bucket available for the Bank to buy, this was the area of the gilt market that was likely to benefit the most.

At the moment, the Bank owns a substantial amount of 2027 gilts but not a lot of the other gilts within this 7-15 year bucket, said Russell. The Bank has also said it will not buy more than 70% of an individual bond issue.

'My view is that the gilts that the Bank of England already has a fairly large holding in (over 60%), but not so large that there isn't much room for them to buy more before hitting their 70% ceiling are likely to benefit the most (such as the 5% 2025s and 6% 2028s),' he said.

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