The Bank of England (BoE) 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 plan to buy securities maturing in 20 years or more in daily tranches of up to £5bn 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 on 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.
‘Panic stations’
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 (QE), and is in contrast to its previous rounds of buying which saw officials set a distinct target. QE was one of the policies criticised 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 175 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.”
The yield on 30-year bonds fell 89 basis points to 4.09% by 1.55pm in London. Ten-year yields fell 38 basis points to 4.12% and the pound slid 0.7% to $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 £875bn. It said it would now postpone the plan until October 31, but the annual target for an £80bn reduction was unchanged.
The pace of buying could initially be carried out at an even faster pace than during Covid-19. The BoE said it would be up £5n of securities per operation and auctions will be conducted on each weekday from today until October 14. While the pace of buying could change, that implies purchases of up to £65bn in the initial period.
QE during the early days of Covid pandemic saw the BoE buy £5.1bn a day across all maturity sectors, and only on three days per week.
On Tuesday, BoE 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.
Bloomberg
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