LONDON
London banks are executing a classic bond carry trade, borrowing billions from the Bank of England's repo operations at minimal cost and deploying the cash into longer-dated gilts where yields have risen sharply. The strategy works as long as the spread between short-term funding costs and gilt yields remains positive—and that spread is widening.
The mechanics are straightforward: borrow cheap from the central bank, buy gilts paying more, pocket the difference. In the current environment, with the BOE holding £488 billion in gilts from its post-crisis asset purchase program, that liquidity tap remains open. Banks are taking full advantage before any shift in monetary policy narrows the spread.
Personal holdings by London bankers have also spiked following recent gilt selloffs, with the January 2028 maturity emerging as a favored positioning. These institutional players are betting that the current yield premium compensates for duration risk—the risk that gilts fall if rates rise sharply from here.
Market pricing now reflects a higher probability of rate increases than cuts from the Bank of England, a signal that the carry window may not remain this attractive indefinitely. Governor Andrew Bailey and Chief Economist Huw Pill's messaging ahead of the November meeting will be critical; any tightening guidance could compress spreads and end the trade.
The BOE has not signaled an immediate policy shift, but duration risk is real. A sharp rate move up would mark down the value of the gilt holdings these banks are accumulating. For now, the yield pickup justifies the exposure.
