BOE Steps Back Into Bond Market to Restore Stability

28 Sep 2022

The Bank of England staged a dramatic intervention to stave off an imminent crash in the gilt market by pledging unlimited purchases of long-dated bonds.

With the fallout from Prime Minister Liz Truss’s tax cuts still ripping through UK asset prices, the central bank had been warned that collateral calls on Wednesday afternoon could force investors to dump government bonds, according to a person familiar with its decision making.

The BOE kicked off the plan on Wednesday afternoon by purchasing just over £1 billion ($1.07 billion) of securities maturing in 20 years or more, less than the £5 billion it said it was prepared to buy at each auction. Operations will continue every weekday until Oct. 14.

The announcement of the purchases had an immediate impact on the gilt market, putting yields on 30-year debt on track for the biggest drop on record. They earlier climbed to the highest since 1998.

The central bank warned that continued dysfunction would threaten financial stability and even damage the economy. It also delayed the start of its plan to start actively selling its existing holdings of bonds, due to begin Monday.

“The purchases will be carried out on whatever scale is necessary,” the central bank said, language reminiscent of former European Central Bank President Mario Draghi’s 2012 pledge to do “whatever it takes” to save the euro.

The BOE decided to intervene to get ahead of a potential crisis that could have hit within hours. It was concerned collateral requirements on liability-driven investment strategies, such as those at pension funds, would have turned many into forced sellers of long dated gilts, according to a person familiar with the situation.

The cash call would have happened this afternoon, turning the market one-sided and risking a precipitous crash. Investment banks and fund managers have warned the government in recent days of the problem.

UK 30-year yield is set for a record drop two days after a historic jump

The initial assessment of the BOE announcement from Bloomberg Economics was a blunt two words: “Panic Stations.”

The rout in bond markets stems from the government’s determination to push through the biggest package of unfunded tax cuts in half a century in the face of widespread opposition from economists and investors. The International Monetary Fund on Tuesday urged Truss’s government to reconsider the plan, and Moody’s Investors Service warned that it could threaten the country’s credit rating.

The BOE’s intervention, which will be financed by the creation of new reserves, is effectively open-ended quantitative easing, and is in contrast to its previous rounds of buying which saw officials set a distinct target. QE was one of the policies criticized by Truss and her supporters during the summer’s leadership contest.

The bank said the purchases will be strictly time limited and “are intended to tackle a specific problem in the long-dated government bond market.”

While QE is normally a monetary operation, the step was recommended by the BOE’s Financial Policy Committee, amid fears of a “material risk” to financial stability that “would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy,” the BOE said.

Even so, it will have consequences for monetary policy and could mean officials decided they need to act in a bigger way in November, when markets are pricing in 170 basis points of rate increases.

“The MPC will make a full assessment of recent macroeconomic developments at its next scheduled meeting and act accordingly,” the BOE said Wednesday. “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.”

EXPLAINER: Why Bank of England’s Remit Has Become Political

What Bloomberg Economics Says...
“The intervention buys time for Chancellor Kwasi Kwarteng to re-consider the government’s policies and for the MPC to take stock ahead of its November meeting. We expect a 100-basis-point rate increase on Nov.3, with risks skewed to a larger, earlier move.” --Read the full REACT here.

The yield on 30-year bonds fell 103 basis points to 3.96% as of 4:38 p.m. in London. Ten-year yields fell 43 basis points to 4.08% and the pound was little changed at $1.0738.

The return to bond buying comes just days before the BOE was due to start selling the mammoth holdings of government securities it built up since the financial crisis, which peaked at £875 billion. It said it would now postpone the plan until Oct. 31, but the annual target for an £80 billion reduction was unchanged.

Just yesterday, BOE Chief Economist Huw Pill said the bank’s program of government bond sales should go ahead as planned next week if the market repricing stays orderly.

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