Bank of England prepares to keep interest rates up with bond sales in focus By Reuters

By Andy Bruce

(Reuters) – The Bank of England looked set to keep interest rates on hold on Thursday as it awaited signs that inflationary risks were abating, focusing on a decision on bond sales that could fuel Finance Minister Rachel Reeves’ first budget.

British inflation held steady in August but accelerated in the services sector, which is key for the BoE, showing why forecasters expect interest rates to fall more slowly than in the United States and the euro zone.

The Federal Reserve went in for an unusually large cut of half a percentage point on Wednesday, a move that reflected “increasing confidence” in the inflation outlook, according to Chairman Jerome Powell.

The BoE’s monetary policy committee is likely to take a much more cautious tone on Thursday.

All 65 economists in a Reuters poll published last week said they were likely to keep rates at 5.0% after cutting them in August from a 16-year high of 5.25% .

Financial markets indicated about a 1-in-4 chance of a cut after Wednesday’s inflation data, compared with 1-in-3 the day before.

News on price pressures was mixed. Wage growth – another key measure for MPC members – cooled as expected last month and the economy stagnated in July.

But the Decision Maker Panel – a business survey favored by the MPC – showed that a downward trend in wage growth expectations had stopped. In addition, services inflation rose in August, albeit largely due to volatility in air fares.

Tim Graf, head of macro strategy at State Street (NYSE:) Global Markets, said the inflation data “reinforces the belief, largely held by markets, that the Bank of England will hold out at (the) policy meeting.”

The consensus of economists polled by Reuters indicated a 7-2 split in favor of holding rates. Last month, the MPC voted 5-4 to cut it, but said some of the five saw the decision as finely balanced.

CRUNCH TIME QT

Bond investors are eyeing Thursday’s annual decision on the pace of the BoE’s quantitative easing program – the sale of hundreds of billions of pounds of British government bonds bought in previous attempts to stimulate the economy.

In September 2023, the MPC voted to reduce the BoE’s gilts stockpile by £100bn ($130bn) through asset sales and maturing bonds, up from £80bn in the previous 12 months.

Some MPs have criticized the QT program for crystallizing the losses suffered by the BoE, which has been buying sprues in recent years at prices far higher than their current selling value. These losses are paid for by already stretched taxpayers.

But the BoE could announce a QT acceleration on Thursday. Around £87bn is set to mature over the next year, leaving just £13bn for active sales.

Citi and JPMorgan expect the BoE to extend the program to £120 billion so it can maintain the volume of active gold sales.

Francis Diamond, head of UK, euro and global inflation strategy at JPMorgan, said in a research note that market reaction to such a move would be limited.

Governor Andrew Bailey said the QT was needed to restore the BoE’s firepower if it was to stimulate the economy again with bond purchases.

Given the impact on the state budget, Finance Minister Reeves will be following Thursday’s decision. When pressed by MPs, she said QT was an operational matter for the BoE.

But many economists believe Reeves will change the government’s fiscal rules to rule out the impact of the BoE’s QT programme. That could give her several billion pounds of extra fiscal space in her inaugural budget, due on October 30, when she is under pressure to increase public spending.

The New Economics Foundation think tank said that keeping the BoE’s bond sales at their current rate would cost taxpayers just under £24bn a year until 2028/29. It said £13.5 billion could be saved annually by ending active sales.

“The Bank of England should reflect on the value for money of such an election and the Chancellor should come to terms with the fact that his fiscal rules impose arbitrary constraints on his spending decisions,” said NEF economist Dominic Caddick.

($1 = £0.7648)