UK cliff edge arrives as Bank of England prepares to end bond buying

The Bank’s Financial Stability Committee announced on September 28 a two-week emergency purchase program for long-term UK government bonds.

Mayor Bloomberg | Mayor Bloomberg | fake images

LONDON (AP) — The Bank of England’s emergency bond-buying program draws to a close on Friday, and traders remain nervous as the volatility in the UK bond market looks set to continue.

The central bank initially announced the two-week intervention in the long-term bond market on September 28, after being informed that several liability-driven investment (LDI) funds, held by pension plans, were to Hours of collapsing like UK government bonds. prices plummeted.

The market volatility was triggered by the British government’s so-called “mini-budget” on September 23, which sparked widespread backlash over billions of pounds in unfunded tax cuts while spooking both bond markets and investors. british pound.

Finance Minister Kwasi Kwarteng will now deliver an updated medium-term fiscal plan on October 31, the same day the Bank of England is due 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 and flew back to the UK as the government met to address the country’s economic crisis. Reports suggest a U-turn in the mini-budget’s £43bn unfunded tax cuts could be imminent.

The Bank’s Monetary Policy Committee then meets on November 3 to determine its next move on interest rates, and Chief Economist Huw Pill has indicated that the country’s new fiscal framework will require a “significant” monetary policy response. as policymakers seek to control the sky. high inflation.

Prime Minister Liz Truss’s government maintains its sole target is 2.5% annual GDP growth, but the focus on fiscal support for the economy means that Downing Street and Threadneedle Street are pulling in opposite directions, with the Bank of England trying to tighten its belt to cool down the economy and contain inflation.

The BOE Pill also highlighted that recent actions taken to ensure the orderly functioning of the market and financial stability sought to preserve the effectiveness of monetary policy, but should not be considered monetary policy actions per se.

Bond yields, which move inversely to prices, soared again on Wednesday after Bank of England Governor Andrew Bailey confirmed that the emergency support mechanism would be withdrawn on Friday, leaving LDI with around 72 hours to shore up their balances. the 30 year old gold the yield reached 5% for the first time since before the Bank’s historic intervention.

With the golden turbulence 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.

“The Bank of England is very likely to resume buybacks because two and two does not equal 22; it is virtually impossible to remove the massive amount of negative yielding bonds on pension fund balance sheets without serious pain, so It is very likely that they will intervene in a specific way and I would be attentive because the next one is the ECB,” said Daniel Lacalle, chief economist at Tressis Management.

“What we are experiencing today in the UK is likely to be replicated by Italy, France, Germany even in the coming months.”

We will continue to see an aggressive Bank of England, says chief economist

Luke Bartholomew, Senior Economist at Abrdán, noted the level of market uncertainty surrounding the government’s ability to deliver a credible fiscal package by the end of the month, suggesting volatility may persist and force further Bank interventions.

“Clearly, the Bank is seeking to allay concerns about fiscal dominance, where it would be forced into more permanent operations to support gilt yields in response to volatility and appreciation caused by government fiscal policy,” he said. Bartholomew in a note on Wednesday.

“While the Bank certainly needs to reassert 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 package.

Chris Lupoli, UK inflation and rate strategist at BNP Paribastold CNBC on Thursday that the Bank of England remained focused on temporary purchases that serve as “backstops.”

“This is also exemplified by the different valuation approach they are employing in auctions, compared to the approach of QE purchases based on historical monetary policy,” he said, pointing to the relatively low values ​​of daily purchases made by the Bank. until Wednesday.

“It is also reflected in the fact that they have only bought a fraction of the total initial maximum endowment, although this is also a direct function of the low number of bonds offered in the auctions.”

Lupoli suggested that the temporary purchases were an “incremental instrument in the BoE’s financial supervision toolbox” and could be implemented again in the future should any “analogous market failure” occur that the Bank sees as a threat to financial stability.

The reality is that the UK is a low-growth economy: fund manager

Crucially, the other two additional measures, the Temporarily Extended Collateralized Repo Facility (TECRF) and the expansion of collateral eligibility established for Long-Term Indexed Repo operations, will not end on Friday.

Lupoli highlighted that the TECRF, which is intended to allow banks to help alleviate liquidity pressures on clients’ LDI funds through liquidity insurance operations, has been expanded to include non-financial corporate bonds above a certain quality. credit.

“Importantly, the ability to withdraw cash on this basis (for the initial 30 days, which may be renewed) will be extended until November 10, 2022 – in other words, this important cash-generating conduit, specifically targeting the side of the assets of the pension funds will continue beyond this Friday”, he added.

Leave a Comment