The Bank of England re-started its gilt buying operation in August 2016.  This action was taken to provide insurance against an anticipated slowdown in the wake of the EU referendum vote.  As part of the QE programme the Bank also re-invests the proceeds of the redemptions within the Asset Purchase Facility.  The re-investment of the proceeds of the gilt that matured in January 2017 will be completed on March 13.

The impact on the gilt market of the Bank of England’s buying has been significant.  The Bank of England buys bonds in three maturity bands, 3yr-7yr, 7yr-15yr, and everything greater than 15yr.  However, the Bank has a self-imposed limit that it will not own more than 70% of any one gilt.  This restriction means that in the 3-7yr bucket, of the ten bonds available only one is over the 70% limit.  In the over 15yr bucket all nineteen bonds are available to purchase.  However, in the 7-15yr bucket, of the seven bonds only three have been available for the Bank to buy.

This has the result of distorting the price of bonds with very similar features.  For instance, the 2.25% 2024 gilt has been available for the Bank to buy but the 5% 2025 gilt has not.  These two bonds have an identical duration, that is, price sensitivity to changes in yield.  The 2024 gilt at one point offered 8bps more yield than the 2025.  At the moment it offers around 5bps more yield.

An active fund can oppose these distortions created by central bank actions and pick-up the extra yield for no extra risk.

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