18th September 2026
The Bank of England's decision to leave interest rates unchanged at 3.75% attracted most of the attention this week. But another decision could prove almost as important for the cost of borrowing in Britain.
The Bank has changed the way it will unwind the huge stock of government bonds it accumulated during years of quantitative easing, or QE.
The Bank still holds around £488 billion of UK government bonds, known as gilts. It has been gradually reducing this holding through a process known as quantitative tightening, or QT.
But the gilt market has come under considerable pressure. Thirty-year government borrowing costs recently reached their highest level since 1998 as bond markets around the world sold off. The Bank has therefore decided to pause its active gilt sales for the next six months and stop selling long-dated gilts altogether.
That produced an immediate reaction. Gilt prices rose and yields fell as investors welcomed the reduction in the immediate supply of bonds coming onto the market.
What does all this mean?
To understand it, it helps to think of the bond market as another form of borrowing.
When the Government wants to borrow money, it issues gilts. Investors buy them and receive interest in return.
The yield on those gilts is important because it influences the cost of borrowing throughout the economy.
Mortgage rates, business loans and other forms of long-term borrowing are not directly set by the Bank Rate. They are influenced by financial-market interest rates, including government bond yields.
That means a sharp rise in gilt yields can make borrowing more expensive even if the Bank of England has not raised Bank Rate.
The Bank's decision to slow its gilt sales is therefore partly an attempt to avoid adding unnecessary pressure to an already volatile market.
But there is an important second part to the announcement.
The Bank still intends eventually to get rid of its remaining QE holdings. It has decided that the stock of gilts held for monetary-policy purposes should ultimately fall to zero, with the process expected to continue until around 2034.
After accounting for bonds that will mature naturally and £120 billion of long-dated gilts that will be retained to back banknotes, around £368 billion remains to be unwound. The Bank intends to reduce this at an average rate of about £46 billion a year, including £20 billion of active sales.
So this is not the end of QT. It is more a change in how the Bank gets there.
Could this push interest rates higher?
There is an interesting complication.
The Bank itself estimates that QT has added only around 20 to 30 basis points to long-term gilt yields since the process began, while the much larger increase in long-term borrowing costs has mainly reflected global economic uncertainty, heavy government borrowing and changes in demand for long-term UK debt.
In other words, QT is not the main reason British borrowing costs have risen.
Nevertheless, the Bank has to take those financial conditions into account when setting Bank Rate.
And this is where the current inflation problem becomes important.
The Bank expects UK inflation to rise further, potentially above 4% early next year, partly because of the continuing energy shock. At the September meeting, three members of the nine-member Monetary Policy Committee wanted to raise Bank Rate immediately from 3.75% to 4%. The majority voted to hold.
The Bank also says that UK financial conditions have tightened significantly since the Middle East conflict began. Higher market interest rates are already feeding through into mortgages and business borrowing. The quoted rate on a typical two-year fixed mortgage is around 0.95 percentage points higher than before the conflict.
This creates a difficult balancing act.
The Bank wants interest rates high enough to prevent higher oil, petrol and diesel prices from becoming permanently embedded in inflation. But it also does not want to put unnecessary additional pressure on an economy already facing higher borrowing costs.
What happens next?
The bond-market announcement therefore does not automatically mean another rise in Bank Rate.
In fact, by reducing the immediate pressure from gilt sales, the Bank has made one part of the borrowing-cost problem slightly easier.
The bigger threat remains inflation.
If oil and diesel prices fall as the Middle East situation improves, inflation could begin to ease and the pressure for higher Bank Rate could diminish.
If energy prices remain high and businesses begin passing their increased transport and production costs into prices and wages, the Bank may have to keep rates high for longer or consider further increases.
There is also a warning from the bond market itself. Even with the Bank slowing its gilt sales, investors are demanding relatively high returns for holding long-term UK government debt.
That matters because Britain needs to borrow large sums of money.
So the Bank of England is now fighting inflation on two fronts.
Bank Rate controls the price of money directly, while the gilt market determines much of the cost of long-term government and private borrowing.
The latest announcement is designed to prevent the second from becoming unnecessarily disruptive.
But it cannot solve the underlying problem.
If fuel prices continue rising, inflation remains stubborn and investors continue demanding higher returns on government debt, Britain could still face a period of higher borrowing costs for longer.
The next few months will therefore be crucial. The direction of oil prices may ultimately have more influence on UK interest rates than the Bank's latest decision on gilts.