FILE PHOTO: The Bank of England (BoE) building is reflected in a sign, after the BoE became the first major global central bank to hike rates since the coronavirus disease (COVID-19) pandemic, London, Britain, December 16, 2021. REUTERS/Toby Melville/File Photo/File Photo

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  • BoE rate hike to 1% is a prerequisite for active gilt selling
  • Little direct advice on timing or size of sales
  • Some economists think sales could start as early as June
  • BoE aims for modest impact on markets and economy

LONDON, April 26 (Reuters) – The Bank of England is expected to take its first steps next week towards selling some of the 875 billion pounds ($1.11 trillion) of government bonds it has accumulated between 2009 and 2021, leading the markets into uncharted territory.

Investors believe the BoE, seeking to prevent the recent surge in inflation from becoming a long-term problem, will raise its main interest rate on May 5 to 1%, the level at which it said it would “consider to start” the pure and simple obligation Sales.

The big question for the markets is when these sales will begin. Analyst estimates range from June through 2023.

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The BoE said in February it would stop reinvesting proceeds from maturing gilts, echoing decisions by the US Federal Reserve in 2017 and 2018.

But the active selling raises more complex questions about the timing, scale and impact on the UK economy as it faces the difficult combination of the highest inflation in 30 years and growth staggering.

The reduction in gilt holdings has the potential to drive up borrowing costs across the economy, reducing inflation but also slowing growth, unlike the quantitative easing carried out by most Western central banks since the 2008 financial crisis.

No other major central bank has started a similar process of active selling.

“We are venturing into new and uncertain territory,” said Sanjay Raja, chief UK economist at Deutsche Bank.

Raja expects gilt sales to start in August or September and amount to around 3.3 billion pounds per month through 2022 and 2023.

Combined with £72bn of gilts maturing this year and next, that would add 15-25 basis points to long-term bond yields – a slight increase in borrowing costs given the 90 basis point rise 10-year gilt returns so far this year.

Overall, the broader impact on sales growth and inflation should initially be very small, Raja said.

The BoE said it wanted its gilt sales to be predictable and avoid market disruptions, and that interest rates would remain the primary tool for controlling inflation.

His main goal is simply to reduce the size of gilt holdings – which have reached a scale that could limit his room for maneuver in future recessions – and he thinks the broader economic impact will be limited.

However, with consumer price inflation at 7% in March and rising, an early start to gilt selling would help the BoE show it’s serious about reining in rising prices, fixed income strategist Mark Capleton said. from Bank of America.

“The Bank’s soft, gentle approach, where quarter-point steps seem to be the modus operandi, seems rather tentative,” he said.

Bank of America expects the BoE to begin gilt sales in June, initially selling 5 billion pounds of gilts per month, rising to 9 billion from November.

NatWest Markets strategist Imogen Bachra said the BoE may prefer to take stock of the impact of its interest rate hikes and slowing growth before announcing a 2023 program in November of around £50 billion in gold sales.

“They don’t seem to be in a rush to start this process. They’re much more focused on rate hikes for now,” she said.

The BoE has raised rates three times since December, more than any other major central bank. Financial markets forecast rates reaching 2.25% by the end of 2022. Most economists expect fewer increases.

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The BoE is the largest holder of UK government bonds, holding £847bn of conventional gilts, or 45% of the total outstanding, after £28bn of its bonds matured in March.

The average maturity is much longer than bonds and mortgage-backed securities held by the Fed or the European Central Bank.

Simply waiting for gilts to mature, it would take until 2030 for BoE holdings to return to pre-pandemic levels – and 2071 for the last of the gilts to come off the BoE books.

“We can’t have a constant rise in central bank balance sheets and they never go down,” Bailey said on Friday.

But the BoE wouldn’t sell gilts in choppy markets, he said. Selling in a volatile market would make the impact of selling on borrowing costs and the wider economy both larger and harder to predict, the BoE believes.

ING economists say wider bid-ask spreads for gilts and increased volatility in swap option prices will force the BoE to wait nine to 12 months before starting sales.

BoE policymaker Catherine Mann – who has been keen to raise interest rates – said the recent increase in volatility was a factor for her regarding the pace of quantitative tightening.

Economists don’t expect much clarity next week on the BoE’s longer-term plans.

He says he doesn’t expect to completely undo his balance sheet explosion, due to a long-term increase in the amount of cash banks have deposited with him since the 2008 financial crisis.

Deutsche Bank said BoE gilts could fall by 300 billion pounds by the end of 2025. NatWest said it would take until the end of 2026 to write off the 440 billion pounds of gilts bought during the pandemic.

In the short term, the BoE must decide how to sell the gilts in order to get the best return.

A mirror image of the BoE’s three weekly operations to buy the cheapest gilts offered to it in fixed maturity ranges wouldn’t do that, Bank of America’s Capleton said.

Selling more liquid, shorter-dated gilts was likely easier, but the BoE might prefer to keep the maturity structure of its holdings and not focus on selling gilts that will soon mature, the strategists said.

The most effective method would be for the BoE to delegate sales to the UK Debt Management Office (DMO), Capleton said. But in practice, the BoE probably wants direct control over what gilts it sells and when, while trying to avoid a conflict with the £131.5 billion in DMO sales this year.

“QE was kind of a supply-demand tango between the DMO and the Bank of England,” Capleton said. “But it’s debatable whether an offer-offer tango would work or if they’d be stepping on each other’s toes.”

($1 = 0.7857 pounds)

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Reporting by David Milliken Editing by William Schomberg

Our standards: The Thomson Reuters Trust Principles.

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