BOE steps back into bond market to restore stability
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 the government tax-cutting plans still ripping through UK asset prices, the central bank had been warned that collateral calls on Wednesday (Sep 28) afternoon could force investors to dump government bonds triggering a major crash, according to a person familiar with the Bank’s decision making.
The plan to buy long-dated bonds in daily tranches of up to £5 billion (S$7.7 billion) had an immediate effect 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 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.
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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 Prime Minister Liz Truss to reconsider the plan, and Moody’s Investors Service warned that it could threaten the country’s credit rating.
The BOE’s intervention is effectively open-ended quantitative easing, and is in contrast to its previous rounds of buying which saw officials set a target and a likely timeframe. The bank’s QE buying was one of the policies criticised by Truss and her supporters during the summer’s leadership contest.
Still, 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.
“This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy,” the BOE said. The buying will be financed by the creation of new reserves.
“The purchases will be carried out on whatever scale is necessary to effect this outcome,” 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 bank added the purchases will be strictly time limited and “are intended to tackle a specific problem in the long-dated government bond market.” Auctions will take place from today until Oct 14.
The yield on 30-year bonds fell 85 basis points to 4.14 per cent as of 1.38 pm in London. Ten-year yields fell 40 basis points to 4.11 per cent and the pound slid 0.7 per cent to US$1.0660.
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, Chief Economist Huw Pill said the bank’s programme of government bond sales should go ahead as planned next week if the market repricing stays orderly.
The BOE also reiterated that a monetary policy response to the fiscal plan will probably come in November.
“The MPC will make a full assessment of recent macroeconomic developments at its next scheduled meeting and act accordingly,” it said. “The MPC will not hesitate to change interest rates by as much as needed to return inflation to the 2 per cent target sustainably in the medium term, in line with its remit.” BLOOMBERG
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