Notably absent from Wednesday’s MPC minutes was any mention of the spread between gilt yields and Overnight Index Swap (OIS) rates.
The OIS is basically a proxy for the markets’ expectation of central bank rates. Which means the gilt yield-OIS spread is a way to sort of examine UK government bond yields while controlling for changing expectations of future interest rates.
Since the BoE’s quantitative easing programme is aimed partly at keeping gilt yields very low, what the Bank really wants to see in terms of the gilt yield-OIS spread is a narrowing — indicating that gilt yields are declining in step with market expectations for future interest rates.
And in the December minutes, the Committee made no small meal of the thing:
The narrowing of the spread between gilt yields and corresponding OIS rates, which Committee members had viewed as an indicator of the positive impact from the asset purchase programme, had partly reversed over the previous two months . . . Despite the fall in UK government bond yields, their spreads over OIS rates had increased for the second successive month. The ten-year spread had fallen by around 90 basis points between the publication of the February Inflation Report and the beginning of August, but had risen by over 50 basis points subsequently. There were a number of possible explanations for this turnaround. First, gilt yields might have risen relative to OIS rates in anticipation of higher future gilt issuance. Second, market participants might have revised down their expectations of the demand for gilts from banks during the transition to the FSA’s new liquidity requirements. And third, it was possible that the gilt-OIS spread could have increased if market participants had altered their views about the eventual scale or pace of the MPC’s asset purchase programme. The relative importance of these, or other, potential explanations in explaining the recent increase in the gilt-OIS spread was unclear.
Since then however, the spread has more or less continued to widen, as you can see from the below chart, courtesy of BNP Paribas, which means it’s slightly odd that the MPC made no mention of the measure in its latest minutes.
Incidentally, according to BNP Paribas’ Alan Clarke, the widening spread:
. . . highlights that much of the benefit of QE has already started to be priced out.