More important than the interest rate decision! Bond investors are closely watching the Bank of England's QT plan.

The Bank of England will announce its latest interest rate decision on Thursday at 19:00 Beijing time. The market widely expects the Bank of England to keep the benchmark interest rate unchanged at 3.75%. However, the energy price shock triggered by the Middle East war is prompting intense debate among policymakers and investors over "whether to raise interest rates." Investors are particularly focused on whether the Bank of England will signal any hint that soaring energy prices could force it to follow the Federal Reserve in raising interest rates. If the Bank of England releases a hawkish signal, UK gilt yields may rise as a result. However, for bond investors, they are more focused on the Bank of England's quantitative tightening (QT) plan for the coming year than on Thursday's interest rate decision. The Bank of England will also release its annual update on Thursday, covering its latest plans to shrink its balance sheet by selling government bonds. The bond market's focus is on whether the Bank of England will scale back or even suspend active sales of bonds from its balance sheet, and any reduction in the scale of the Bank of England's active bond sales could be positive for UK gilts. Since February 2022, the Bank of England has reduced its bond portfolio from a size that had nearly doubled to 489 billion. The bank has said its goal is to sell its entire bond holdings and that it follows three principles interest rates remain the Monetary Policy Committee's (MPC) primary tool; bond sales will not disrupt market functioning; and the selling process should be gradual and predictable. Mizuho strategist Evelyne Gomez-Liechti said: "QT is the more important market event. The related announcement may be more important than the rate decision." Her base case is that the Bank of England will abandon active sales of its bond holdings and instead implement only passive QT, meaning it will allow bonds to roll off its balance sheet naturally as they mature. She said this would support UK gilts. The Bank of England's QT plan involves gradually exiting the UK government bonds purchased under quantitative easing (QE) during the pandemic. These bond sales have been under market scrutiny because they could increase bond selling pressure, and the recent round of selling has already pushed UK long-term borrowing costs to their highest level since 1998 and eroded the UK government's fiscal space. UK long-term gilt yields hover near 1998 highs Remi Olu-Pitan, head of multi-asset growth and income at Schroders, said: "I do think that at some point the institution that is the lender of last resort will ultimately need to step in to support UK government bonds. I think if UK bond yields continue to rise, action will be needed." Morgan Stanley strategists Fabio Bassanin and Luca Salford said that "a sharp increase in UK gilt issuance and a decline in Bank of England holdings" have had a more pronounced impact on long-term UK gilts, while demand for such bonds from pension funds has weakened in recent years. They estimate that QT has added 70 basis points to 30-year UK gilt yields. Data shows that the premium of 30-year UK gilts relative to comparable swap rates one measure of market concerns about bond supply has remained broadly stable this year, despite the sharp surge in yields. Surveys show that market participants expect the Bank of England may slow the pace of balance sheet reduction to 50 billion ($67 billion) per year in the 12 months to October. That implies active sales of UK gilts of about 20 billion. However, a report earlier this week said the Bank of England may stop selling long-term debt altogether, reigniting market discussion of the issue. The plan has drawn criticism because the Bank of England is already incurring losses when selling long-term government bonds and has cost the UK government billions of pounds. However, even if the Bank of England stops selling UK gilts, the impact may be only marginal, because UK gilts remain vulnerable to external shocks, such as the Middle East conflict pushing up oil prices and intensifying inflation concerns. QT's impact on long-term UK gilts is limited Some market participants warned that, given the Bank of England's concern that changing its bond sales strategy to cater to the government's fiscal needs could raise questions about the central bank's independence, it may not make any major adjustments beyond the consensus expectation at all. Citigroup strategist Jamie Searle said that while a strategy change is possible, he doubts the Bank of England will "maintain the status quo to avoid blurring QT's monetary policy control."