The spotlight at Thursday's 19:00 monetary policy meeting of the Bank of England has shifted from the interest rate verdict to the trajectory of its quantitative tightening programme.

With rates widely expected to remain unchanged, investors are zeroing in on whether the central bank will scale back or even suspend its active bond-selling operations. Analysts are split on the likely outcome of the QT review, but any reduction in active sales would likely provide a tailwind for UK gilts. Mizuho strategist Evelyne Gomez-Liechti noted that "QT is the more significant market event here, and the impact of any related announcement could far outweigh the rate decision."

UK gilt yields have recently surged to their highest levels since 1998, with the relentless rise in long-term borrowing costs eroding the government's fiscal headroom just as the window before next month's Budget statement narrows. Market sensitivity to every detail of the BOE's QT strategy is now greater than ever.

QT Scale Could Shrink Dramatically, Active Sales May Exit Stage

The central bank's QT programme is designed to gradually unwind the gilt holdings accumulated during pandemic-era quantitative easing. Since February 2022, the BOE has trimmed its portfolio from roughly £980 billion to £489 billion.

A survey of market participants conducted by the BOE indicates widespread expectations that the pace of balance sheet reduction will slow to around £50 billion per year (approximately $67 billion) over the 12 months starting next October, with active bond sales corresponding to roughly £20 billion of that total. However, reports earlier this week suggested the BOE could halt long-dated gilt sales altogether, a prospect that has sparked considerable debate across markets.

Gomez-Liechti's base case is that the BOE transitions from active sales to purely passive QT, allowing bonds to roll off the balance sheet through natural maturity rather than being sold in the secondary market. She believes such a shift would provide meaningful support for gilts.

Pressure Especially Acute at the Long End

According to analysis from Morgan Stanley strategists Fabio Bassanin and Luca Salford, "heavy gilt issuance combined with the continued decline in BOE holdings" has disproportionately impacted long-dated bonds, partly because traditional buyers such as pension funds have seen their demand for long-end gilts shrink notably in recent years. The two strategists estimate that QT operations have added roughly 70 basis points to 30-year gilt yields.

The premium of 30-year gilts over equivalent-maturity interest rate swaps, a gauge of market concerns about bond supply, has remained broadly stable this year even as yields have climbed sharply. Meanwhile, the current active sales of long-dated bonds are being executed at a loss, generating billions of pounds in losses for the UK government and intensifying external criticism of the programme.

Pausing sales may offer limited relief, independence concerns linger

Even if the BOE announces a halt to active sales, some market participants believe the supportive effect could be quite limited. Gilts remain exposed to external shocks, such as an escalation in Middle East tensions pushing oil prices higher and stoking inflation concerns, factors that QT policy adjustments cannot address.

Schroders multi-asset growth and income head Remi Olu-Pitan remarked that "I do think the lender of last resort will eventually need to step in and support the gilt market. If bond yields keep heading higher, action will become necessary at some point."

Additionally, some market observers caution that the BOE may resist making major changes to its current approach. Citi strategist Jamie Searle said that while a strategy adjustment is possible, he leans toward the BOE "staying the course to avoid blurring the boundaries of monetary policy control over QT." There are concerns that if the central bank alters its sales strategy to accommodate government fiscal needs, questions could arise over its independence.

The BOE's stated objective is to eventually dispose of its entire gilt stockpile, guided by three principles: interest rates remain the primary tool of the Monetary Policy Committee; bond sales must not disrupt normal market functioning; and progress should be gradual and predictable. Striking a balance between these principles and market realities will be the core test of this week's decision.