By Mark McSherry — The UK central bank announced on Wednesday morning it will “carry out temporary purchases of long-dated UK government bonds from 28 September” to avoid “a material risk to UK financial stability.”
Some financial analysts claimed the move was designed to stop a run on UK pension funds.
The Bank of England said its purchases of the UK government debt securities “will be carried out on whatever scale is necessary” and will be “fully indemnified” by the UK Treasury.
It said the purpose of these large purchases of UK government bonds will be to “restore orderly market conditions.”
The central bank said it “stands ready to restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses.”
The bank also said it was keeping its goal to reduce its £838 billion of gilt holdings by £80 billion over the next year, but said it has postponed the gilt sales that were due to commence next week — until October 31.
Earlier, the International Monetary Fund (IMF) and ratings agency Moody’s had piled the pressure on the UK to reverse the new strategy set out by finance minister Kwasi Kwarteng on Friday in a move that he said would ignite economic growth.
The rare intervention from the IMF emphasized the severity of the UK’s situation, with the value of the pound and UK bonds having collapsed since Friday.
The latest crisis to hit the UK state was triggered by Kwarteng’s plans for deep tax cuts and deregulation.
Moody’s said large unfunded tax cuts were “credit negative” for the UK, risking structurally higher funding costs that could weaken the economy.
“The BOE intervention was required to prevent a vicious cycle becoming even more dangerous for pension funds forced to sell their gilt exposures,” Calum Mackenzie, an investment partner at Aon, told Bloomberg.
“The market’s swift and significant reaction underlined the big risk faced by pension funds who have had or who could have had their liability hedges reduced.”
Before the central bank’s intervention, Mackenzie had said: “Any pension funds which has used even moderate levels of leverage are struggling to keep pace with the moves.
“You have a bit of a death spiral potentially where pension funds in particular are being forced to sell because they’re breaching their leverage agreements with their LDI counterparties.”
UK government bond prices rose after the Bank of England announcement, with a drop in gilt yields suggesting the central bank’s plan is working.
“While this is welcome, the fact that it needed to be done in the first place shows that the UK markets are in a perilous position,” said Paul Dales, chief UK economist at Capital Economics, a consultancy.
“It wouldn’t be a huge surprise if another problem in the financial markets popped up before long. Either way, the downside risks to economic growth are growing.”
Before the BoE’s decision, traders had said the £2.1 trillion-pound gilt market was seizing up.
The Bank of England statement read: “As the Governor said in his statement on Monday, the Bank is monitoring developments in financial markets very closely in light of the significant repricing of UK and global financial assets.
“This repricing has become more significant in the past day – and it is particularly affecting long-dated UK government debt.
“Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability.
“This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.
“In line with its financial stability objective, the Bank of England stands ready to restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses.
“To achieve this, the Bank will carry out temporary purchases of long-dated UK government bonds from 28 September.
“The purpose of these purchases will be to restore orderly market conditions.
“The purchases will be carried out on whatever scale is necessary to effect this outcome. The operation will be fully indemnified by HM Treasury.
“On 28 September, the Bank of England’s Financial Policy Committee noted the risks to UK financial stability from dysfunction in the gilt market.
“It recommended that action be taken, and welcomed the Bank’s plans for temporary and targeted purchases in the gilt market on financial stability grounds at an urgent pace.
“These purchases will be strictly time limited. They are intended to tackle a specific problem in the long-dated government bond market.
“Auctions will take place from today until 14 October. The purchases will be unwound in a smooth and orderly fashion once risks to market functioning are judged to have subsided.
“The Monetary Policy Committee has been informed of these temporary and targeted financial stability operations.
“This is in line with the Concordat governing the MPC’s engagement with the Bank’s Executive regarding balance sheet operations.
“As set out in the Governor’s statement on Monday, the MPC will make a full assessment of recent macroeconomic developments at its next scheduled meeting and act accordingly.
“The MPC will not hesitate to change interest rates by as much as needed to return inflation to the 2% target sustainably in the medium term, in line with its remit.
“The MPC’s annual target of an £80bn stock reduction is unaffected and unchanged.
“In light of current market conditions, the Bank’s Executive has postponed the beginning of gilt sale operations that were due to commence next week.
“The first gilt sale operations will take place on 31 October and proceed thereafter.
“The Bank will shortly publish a market notice outlining operational details.”
Daniel Mahoney, UK Economist at Handelsbanken: “UK financial markets have seen exceptional volatility over the past few days. On Thursday last week, the Bank of England raised interest rates by 50bp and triggered active sales of its gilt holdings to speed up the process of Quantitative Tightening.
“Despite markets pricing in a 75bp increase, Sterling remained fairly steady. Then came the Chancellor’s fiscal statement on Friday that announced a fiscal loosening equating to 45bn GBP per year by 2026-27, which led to an immediate negative reaction in UK currency and gilt markets.
“It is widely thought that further statements made over the weekend increased market concern about the fiscal credibility of the Government’s future plans, leading to further pressure on Sterling and Gilts on Monday and Tuesday …
“Even prior to the ‘mini-budget’, Sterling had faced a challenging few weeks: since the beginning of August, the Pound was roughly 7% down against the US dollar and its effective exchange rate – which compares against a basket of currencies – had dropped by roughly 4% over the same time period.
“Since the mini-budget, the Pound’s effective exchange rate has fallen by roughly another 4%. Perhaps more concerning was what was happening in the gilt market.
“10 year gilt yields, for example, jumped by over 100bp over three days of trading following the mini-budget, well in excess of increases seen in other major European economies – including Italy, which is going through considerable political instability at the moment …
“Weakness in Sterling gives the Bank of England a major challenge given it will feed medium-term inflation pressures due to the UK’s high-import dependence.
“However, movements in the gilt market will no doubt be of even more concern due to the implications for financing UK Government debt. The Bank has today announced that it will begin temporary purchases of long-dated gilts and postpone its plans for sales of gilts, reversing its previous position that was unanimously agreed at the MPC’s latest meeting just last week.
“Initial reaction from the gilt market to the Bank’s announcement has been positive, yet falls in yields have not come close to offsetting the increases seen over the past few days. And this move from the Bank raises questions around the Bank’s credibility given it only announced active QT less than a week ago.
“And, of course, compared to previously announced policy, this move will be inflationary at a time of already high inflation, and market expectations for interest rates are now around 6% by mid-2023. Interest rates at anything like these levels will have a hugely negative impact on growth prospects and lead to serious issues for many households coming off fixed-rate mortgages.
“The Bank of England may end up facing a challenging choice between permitting inflation above target for a prolonged period or prompting a ‘hard-landing” for the UK economy.
“It will be important for the Government to offer confidence to markets about the credibility of their fiscal plans, which the Chancellor currently plans to provide in November. Given market turbulence, it is not unforeseeable for Sterling to reach parity with the Dollar before that point – although this is not currently our baseline forecast.”
Victoria Scholar, Head of Investment, Interactive Investor: “The Bank of England is stepping in to calm the bond market turmoil.
“Its unlimited bond purchases are aimed at stemming the market’s recent slide after the Chancellor’s mini-budget sent gilt yields soaring.
“Although the central bank refrained from an emergency rate hike to offset the slide for sterling in FX markets, it has now intervened in the bond market.
“Yields dropped in response with a flattening of the yield curve and long-dated bonds rallying. The Financial Policy Committee has a mandate to ensure the stability of the financial system which is why it has stepped in today by buying 30-year gilts.
“The intervention has resulted in some respite for this week’s bond market volatility. The Bank of England has demonstrated its resolve to restore order to fixed income markets.
“The Monetary Policy Committee is expected to carry out a jumbo rate hike at the start of November but the pound remains under pressure. Despite a brief pause in the selling yesterday, the downtrend for cable continues with GBP/USD shedding more than 20% this year.”
Stuart Clark, portfolio manager at Quilter: “We have just seen the Bank of England (BoE) intervene in the gilt market today to try and calm the situation and this should provide some reassurance to the market.
“However, the BoE is trying to slow down all the plates spinning in the air without letting any fall and the Treasury during the ‘mini-budget’ on Friday threw a bunch of marbles onto the floor to make it more challenging.
“By instigating targeted, controlled and (apparently) time limited intervention the BoE will try to support the economy in order to avoid a more expensive bailout if conditions continue to materially deteriorate while maintaining independence.
“Above all we need to see the government regain credibility with domestic and international investors and explain how they plan to pay for these tax cuts other than just through borrowing.”
Susannah Streeter, Senior Investment and Markets Analyst, Hargreaves Lansdown: “The Bank of England is now pursuing a topsy turvy set of policies, unleashing a fresh bond buying spree to try and bring down punishing rates – while at the same time still signalling it will aggressively hike interest rates to try and rein in runaway inflation.
“This shows what a bind the bank is currently in. It knows ultra-high bond yields will cause a ricochet of problems for companies and consumers and potentially cause instability in the housing market but it’s also very worried that the tax cutting spree will could cause inflation to rise to dangerous levels.
“The move that bank officials have made to step in now, just two days after it indicated it would wait until
“November, smacks of a bit of panic and also of frustration that the government appears to be digging in its heels, reluctant to perform a political U-turn.
“Instead, the Bank of England has been forced to pursue a monetary U-turn, an abrupt change of policy as the Bank’s monetary policy committee had been pursuing a policy of selling down the Bank’s bond holdings.”
Alastair George, Chief Investment Strategist at Edison Group: “On Monday the Bank of England signalled it would wait until November to fully assess the impact of last Friday’s mini-budget.
“But even if pressed to action by market dysfunction, today’s announcement of gilt purchases in the interests of financial stability is a welcome development as it shows a willingness to promptly intervene when necessary, ensuring speculation carries the risk of sharp losses.
“What will be important will be the discussions behind the scenes leading up to this announcement – at first sight this intervention is completely opposed to the current target to reduce the Bank’s holdings of gilts by £80bn each year.
“There must have been a high bar for this move and only in coming days will we fully understand if the rationale was just gilt yields spiralling higher as stated.
“If the Bank and the UK government are seen to be cooperating to stabilise UK markets, the crisis could be over sooner rather than later.”
Simeon Willis, Chief Investment Officer at XPS Pensions Group: “The choppy market for gilts seen over the last few days represents the most consequential event for pension schemes’ investment strategies since the onset of the coronavirus pandemic. While the Bank of England’s intervention this morning will calm markets, the immediate effect has been a whiplash effect with yields falling sharply in morning trading.
“While most schemes with hedging in place will have either emerged relatively unscathed from this morning’s movements, some may have been caught out by missed collateral calls resulting in trimmed hedge positions in the last couple of days.
“The Bank’s intervention should hopefully lead to reduced volatility going forwards but schemes should still be proactive in looking at ways to shore up their liquidity position. Many schemes are in a position to reduce risk in light of recent funding improvements. In particular, well-hedged schemes should be focused on maintaining their hedges, while less well hedged schemes should be looking for ways to increase it whilst the favourable pricing lasts.”
Sandra Holdsworth, Head of Rates at Aegon Asset Management: “The Bank of England stepped in today to stop the gilt market from entering a vicious spiral.
“Selling in the both the conventional and index linked gilt market has been intense in recent days. This has led to a huge demand for cash to support derivative structures popular amongst pension funds. Cash has been raised by selling more gilts , the prices fall and the circle continues.
“As a result at a meeting of the Bank of England’s Financial Policy Committee the Bank has noted the risks to UK financial stability from dysfunction in the gilt market and has taken action by announcing temporary and targeted purchases in the gilt market to start immediately.
“The Bank of England has stressed that this operation is purely as a result of market dysfunction and the potential risks to financial stability not a monetary policy decision. However the planned reduction of the balance sheet that was due to start in earlier October has been postponed to the end of the month.”