The UK government’s borrowing costs fell sharply on Thursday after the Bank of England voted to hold interest rates and announced a sweeping overhaul of its bond sale programme.
Yields on both short- and long-term government bonds declined in the immediate aftermath of the decision, as traders reduced bets on further monetary tightening.
Markets also priced in the lower supply of gilts expected to hit the open market following the Bank’s proposed changes to its quantitative tightening approach.
Borrowing costs on the two-year gilt fell eight basis points, nearly a tenth of a percentage point, erasing losses accumulated during a significant sell-off over the past ten days.
The 10-year gilt, considered the benchmark for a government’s long-term capacity to borrow, saw its yield fall nine basis points through Thursday afternoon.
The Bank of England’s Monetary Policy Committee voted to keep its base rate unchanged at 3.75 per cent, despite warning that inflation was set to top four per cent before the end of the year.
Six members voted to hold, while three dissented in favour of a 25 basis point rise, including chief economist Huw Pill.
Some analysts had predicted that deputy governor Claire Lombardelli would join the dissenters, which would have made the vote the closest since February, but the split remained unchanged from July.
Governor Andrew Bailey said there had been a “material increase in energy prices since July, with a consequent effect on the near-term inflation outlook.”
Bailey added: “If the conflict in the Middle East persists for an extended period, as appears to be the case, and the risk of second-round effects emerging increases, it is likely that policy may have to tighten.”
Rate-setters argued that evidence of so-called second-round effects, whereby sudden price rises from a supply shock filter into the wider economy, had yet to appear in official data despite recent escalation in the Iran conflict.
Movements in borrowing costs were most pronounced among longer-dated government bonds, with the 30-year gilt yield falling as much as 12 basis points from highs not seen this century.
That sharp decline followed the Bank of England’s announcement that it would halt all active sales of long-term debt as part of a major restructuring of its quantitative tightening programme.
Under the proposed overhaul, the Bank would sell gilts directly to the Treasury rather than onto the open bond market, keeping long-term debt on its balance sheet until maturity.
Modupe Adegbembo, economist at Jefferies, said: “Halting active long-end sales this year was not a surprise, but pausing sales altogether and opening the door to an alternative sales model did surprise markets.”
Adegbembo added: “Active sales are not the only reasons for long-end gilt underperformance, but reducing the likelihood of future sales removes an important source of pressure on the sector.”
The Bank had previously been accused of stoking borrowing costs and adding unnecessary pressure on long-dated government bonds through its earlier approach to unwinding its post-2008 bond purchases.
Investors have increasingly demanded higher returns to buy 10-year and 30-year gilts amid fears that inflation will remain elevated and concerns over the trajectory of government borrowing.