QT: BOE Slowdown But Not BOJ/ECB Yet
· The BOE will likely slow the pace of QT to GBP50bln pa at the September 17 MPC meeting, but the BOJ/ECB have no current plans to slow QT. The BOJ QT at 6% of GDP is huge and pushing up JGB yields and the BOJ could slow the pace over the winter into the spring once the next 25bps policy rate hike is delivered and if JGB yields spike further (though BOJ QT will still remain the largest of major DM’s). Meanwhile, the ECB is not focused on QT, but could slow the pace in 2027-28 on money market pressures or if a French fiscal crisis blows up sovereign bond spreads.
Ongoing Quantitative Tightening (QT) by BOJ/ECB is one factor behind more elevated long-term yields. What will happen with QT?
Figure 1: 2027 Big DM Budget Deficit and QT (% of GDP)
Source: Continuum Economics
The BOE is widely expected to slow the annual pace of QT from £70bln per annum at the September 17 MPC meeting to around £50bln. The scale of BOE gilt holding reduction is now back to pre-COVID levels (Figure 2) and could argue for an end to active QT and the BOE only to roll off existing redemptions and adopt passive QT like other major central banks ex Fed (Fed is growing U.S. Treasury holdings in line with nominal GDP (Figure 1)). However, the BOE MPC split on the policy rate and the analysis in Box G in the July BOE monetary policy report suggest that the BOE will make an incremental slowdown rather than a major shift – though we would see an end to active Gilt sales in September 2027 and a slowdown to around £30bln (i.e. 1% of GDP). This would all meanthat the BOE is set to do less QT from September than the ECB and especially the BOJ.
Figure 2: BOE Gilt Holdings (GBP Blns)
Source: Datastream/Continuum Economics
BOJ policymakers are focused on the BOJ policy rate debate and JPY weakness and the adverse impact of the huge BOJ QT (we estimate at 6% of GDP in 2027 Figure 1) has not caught attention. Nevertheless, the ongoing surge in (JGB?) 10yr yields is a function of the huge BOJ QT and the risk is for a further spiral higher in JGB yields. The BOJ is unlikely to look at this issue until the next 25bps of BOJ policy rate tightening is delivered, but it is possible that over the winter that the BOJ could slow the pace of QT. It could do this by stopping the reduction in gross bond buying or actually increasing it (remember that the BOJ redemptions are being rolled off and are much bigger than any gross buying). It may take another yield jump in 10-30yr JGB’s to trigger BOJ action. However, BOJ QT is still likely to be substantively higher than ECB/BOE in future years, given the starting point of the gigantic BOJ balance sheet (Figure 3).
Figure 3: BOJ Balance Sheet (% of GDP)
Source: Datastream/Continuum Economics
Finally, the ECB appears comfortable that QT is not a major issue in the EZ. ECB officials acknowledge that QT (at a pace of 2.5% of GDP) is having a mildly restrictive effect on financial conditions (we see more evidence in slow bank lending), but the inflation and policy rate debate dominates. However, we feel that energy prices will come down in 2027 with more shipping through the Straits of Hormuz (here) and this will tilt the ECB policy debate back towards easing. This could also open the door to more flexibility on the pace of QT. The ECB balance sheet is now down to Eur5.9trn versus EUR4.7trn end 2019 (Figure 4) and the ECB at some stage will likely slow QT to avoid money market pressures. This could be 2027 or 2028. Additionally, if France ends up in a fiscal crisis after the April/May 2027 presidential election, then the ECB council could be reluctant to use the Transmission protection instrument (TPI) if a new French government does not commit to fiscal consolidation. Reducing the pace of existing APP and PEPP QT could then be an easier option for the ECB council to reach consensus on to curtail widen sovereign spreads in the EZ.
Figure 4: ECB Balance Sheet (EURs Blns)
Source: Datastream/Continuum Economics