The Bank of England might opt to abstain from this month’s interest rate cutting frenzy, but Thursday’s meeting will still be significant, as it will highlight the BoE’s intricate interplay with the UK Treasury. The BoE’s reluctance to implement its second rate cut of the year is partly due to uncertainties about how it will integrate next month’s budget announcement from the new UK Labour government into its considerations on inflation and growth for the coming year. The UK government’s current indications suggest a stringent budget. This could aid the BoE in its quest to tackle the persistent “last mile” of disinflation in services and wages, potentially paving the way for more rapid monetary easing in the future. And the BoE might inadvertently reciprocate this favor. The Bank is scheduled to unveil next year’s target for reducing its pandemic-inflated balance sheet of gilts. This “quantitative tightening” (QT) plan is technically distinct from its rate policy and is likely something the BoE hopes to implement without much fanfare or disruption. However, the BoE’s QT announcement may not be easily brushed aside. This is partly because it has been one of the few major central banks actively selling bonds to shrink its balance sheet, unlike the Federal Reserve or European Central Bank, which allow debt to mature and roll off organically. This time, there’s an additional twist in the calculation—one that should influence both BoE’s bond market activities in the year ahead and the new Labour government’s fiscal planning for its highly anticipated and contentious first budget statement. As it stands, the prevailing market consensus is that the BoE will simply reiterate last year’s goal of reducing the balance sheet by £100 billion ($131.59 billion) over the next 12 months. This approach aligns with the BoE’s stated aim to be predictable. The challenge, however, is that next year will see a heavier schedule of maturing debt. Therefore, a £100 billion targeted runoff would result in active gilt sales being 75% lower compared to the totals recorded over the past 12 months. Analysts believe that the approximately £13 billion of gilt sales required could be completed by year-end, effectively removing the BoE as a seller for most of next year. This is likely to benefit bond investors and the Chancellor of the Exchequer. A peculiarity in the QT process is that it crystallizes valuation losses incurred on the bonds between the period when the BoE purchased them, when policy interest rates were near zero, and now, when rates are 5%. The price of those bonds has plummeted in the interim. Given that the Treasury is essentially responsible for BoE losses, QT constricts the government’s fiscal flexibility and scope. While these calculations may merely shift the periods in which balance sheet losses are recorded, this additional leeway could still be significant for a new government under pressure to address what it claims is an inherited fiscal deficit of around £20 billion. Not everyone believes the BoE will adhere to the £100 billion QT figure for the year ahead, so the “gift” of fiscal flexibility may not materialize. Deutsche Bank’s UK economist Sanjay Raja thinks the BOE may want to maintain a “more consistent footprint” of gilt sales. He anticipates an increase in the overall QT target to ensure quarterly gilt sales of £5 billion to £10 billion—not least because active sales will need to rise again the following year. The BoE’s estimate of its balance sheet’s “steady state”—that is, the size it will be comfortable with in the long term—implies at least another £230 billion reduction. This suggests the QT process has at least a couple more years to run. However, the question of whether UK finance minister Rachel Reeves will exploit the Treasury’s BoE exposure to manipulate its own self-imposed fiscal rules remains open. There is much speculation about whether Reeves will alter the definition of “public sector net debt” used in its five-year debt reduction pledge by excluding BoE exposure, unlike the previous government. The independent Institute for Fiscal Studies recently estimated that based on the last budget, such a move could create up to £16 billion of “fiscal headroom” for the government. The institute also noted that this move could be justified if used for investment spending and would be tempting as it involves changes “few people understand or care about”. Nevertheless, the think tank stated that shifting goalposts to make the figures add up seemed difficult to justify. “If the government wants to borrow more and spend more, it would ideally make the case for doing so on its own terms, rather than hide behind fiscal jiggery-pokery,” it added. Whether the BoE QT will align with expectations on Thursday remains to be seen.