The Bank’s Financial Stability Committee announced on September 28 a two-week emergency purchase program for long-term British government bonds.
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The central bank initially announced the two-week intervention in the long-term bond market on September 28, after being informed that a number of liability-driven investment (LDI) funds – held by retirement – were hours away from collapsing as UK government bond prices plunged.
Market volatility was triggered by the The UK government’s so-called ‘mini budget’ on September 23which has caused widespread backlash over billions of pounds of unfunded tax cuts while scaring both bond markets and the Pound sterling.
Finance Minister Kwasi Kwarteng will now present an updated medium-term fiscal plan on Oct. 31, the same day the Bank of England plans to start selling gilts as part of its broader monetary tightening efforts.
Kwarteng cut short a visit to the International Monetary Fund in Washington on Thursday, returning to the UK as the government meets to deal with the country’s economic crisis. Reports suggest that a U-turn on £43bn of unfunded mini-budget tax cuts could be imminent.
The Bank’s monetary policy committee then meets on November 3 to determine its next decision on interest rates, and chief economist Huw Pill has indicated that the country’s new fiscal framework will require a “significant” response from monetary policy as policymakers seek to brake the skies. high inflation.
Prime Minister Liz Truss’s government maintains its sole aim is to achieve 2.5 per cent annual GDP growth, but the focus on fiscal support for the economy means Downing Street and Threadneedle Street are pulling in opposite directions, with the Bank of England trying to tighten its belt to cool the economy and contain inflation.
The BOE pill also pointed out that the measures taken recently to ensure the smooth functioning of the market and financial stability were aimed at preserving the effectiveness of monetary policy, but should not be considered as monetary policy measures in themselves. same.
Bond yields, which move inversely to prices, rose again on Wednesday after the Governor of the Bank of England Andrew Bailey confirmed that the emergency support mechanism would be withdrawn on Friday, leaving LDIs around 72 hours to shore up their balance sheets. The gilding 30 years the yield reached 5% for the first time since before the Bank’s historic intervention.
While the gilt turbulence is expected to persist at least until the government’s fiscal update, some economists expect the market to force more targeted assistance from the Bank in the coming weeks.
“It is very likely that the Bank of England will resume redemptions because two and two does not make 22 – it is virtually impossible to painlessly eliminate the massive amount of negative yielding bonds from the balance sheets of pension funds, it is therefore very difficult probably that they will intervene in a targeted way and I would be careful because the next one is the ECB,” said Daniel Lacalle, chief economist at Tressis Gestion.
“What we are experiencing today in the UK is likely to be replicated by Italy, France, Germany even in the coming months.”
Luke Bartholomew, senior economist at Abrn, noted the level of market uncertainty regarding the government’s ability to deliver a credible fiscal package at the end of the month, suggesting volatility could persist and force further Bank interventions.
“Clearly the Bank is trying to dispel concerns about fiscal dominance, where it would be forced into more permanent operations to support gilt yields in response to the volatility and repricing caused by government fiscal policy,” Bartholomew said in a note Wednesday.
“While the Bank certainly needs to reaffirm its independence and the primacy of its price stability mandate, it is far from clear how credible such statements are given the degree of vulnerability exposed in the gilt market. .”
Other support measures persist
The temporary purchase program was only one of the three components of the Bank’s support programme.
Chris Lupoli, UK Rates and Inflation Specialist at BNP Paribastold CNBC on Thursday that the Bank of England remains focused on temporary purchases serving as a “backstop.”
“This is also exemplified by the different valuation approach they use in the auction, compared to the approach of historical QE purchases based on monetary policy,” he said, pointing to the relatively low values daily purchases made by the Bank until Wednesday.
“This is also reflected in the fact that they only bought a fraction of the total initial maximum envelope, although this is also a direct function of the low quantity of bonds offered at auction.”
Lupoli suggested that the temporary purchases were an “additional tool in the BoE’s financial surveillance toolbox” and could be deployed again in the future in the event of a “similar market malfunction” which the Bank considers a threat. for financial stability.
Crucially, the other two additional measures – the Temporary Extended Collateral Repo Facility (TECRF) and the expanded eligibility of collateral set for long-term index-linked repo transactions – will not end on Friday.
Lupoli pointed out that the TECRF, aimed at enabling banks to help alleviate liquidity pressures on clients’ LDI funds via liquidity assurance operations, had been extended to include non-financial corporate bonds above. above a certain credit quality.
“It is important to note that the ability to draw liquidity on this basis (for an initial period of 30 days, which can be rolled over) will continue until November 10, 2022; in other words, this important conduit generating liquidity, specifically for pension fund assets, will continue beyond this Friday,” he added.