BoE Does Another £50bn QE - Buying Strategy Changed

Key points

• The BoE decided today to lift the asset purchase target by £50bn to £325bn. This was in line with our expectation.
• Today's move means that there will be a modest reduction in the net impact of QE. QE will still outpace official bond supply and contribute to keep yields low.
• The BoE changed its buying strategy, which caused the yield curve to steepen.
• The BoE seems relatively relaxed about the potential spillover to CPI, limiting the risk of a revision of the central inflation projection in next week's Inflation Report and keeping the probability for more QE high.

New QE buying strategy causes yield curve to steepen

The Bank of England announced earlier today that it will continue with its quantitative easing programme. Specifically, the Bank of England will purchase £50bn Gilts over the next three months, i.e. monthly buying will decrease slightly from £18.7bn to £16.7bn. As the bond supply in H1 is slightly higher than in Q4, there will be a modest reduction in the net impact of QE. QE will still outpace supply though and today's decision should, therefore, be seen as a loosening of monetary policy intended to keep yields low.

There is one important thing to note about the BoE's QE2 going forward: boundaries between maturity sectors have been adjusted. Future Gilt operations will be in 3-7 years (Mondays), 7-15 years (Tuesdays) and 15+ years (Wednesdays) - previously 3-10, 10-25 and 25-plus. The Bank intends to purchase evenly across the three gilt maturity sectors. According to the DMO, this operational change is intended to help reduce the risk of undesirable frictions in the functioning of the gilt market arising from the concentration of the bank's holdings of gilts in certain maturity sectors.

Our calculations show that the “Monday sector” has been reduced by 45%, i.e. there will be more demand for the bonds left in this sector. The “Tuesday sector” has increased by 17%, i.e. slightly less support to the bonds in this sector from QE. The “Wednesday sector” has increased by no less than 77%, i.e. the Bank of England has a lot to choose from here. It means, in other words, that shorter dated bonds will be supported more by QE going forward, while longer dated bonds will have less support and the yield curve should, therefore, steepen as we have seen since the announcement.

Our view is that the BoE will keep rates low in the coming months with its bond buying. It seems as though the BoE is not particularly worried that additional QE will push CPI higher. The subsequent statement said: “Inflation should continue to fall sharply in the near term...downward pressure from unemployment and spare capacity continues to restrain domestically generated inflation”. The BoE will keep the asset purchase programme under review and we see a good probability of another £50bn QE being announced in May, i.e. asset purchase target up to £375bn.