The Bank of England Expands Bond Market Rescue to Restore Financial Stability in the United Kingdom

Read Time:4 Minute, 12 Second

According to the central bank, a broken government-bond market poses a risk to financial stability.

For the second day in a row, the Bank of England increased its assistance for pension funds, the latest effort to stem the effects of a brutal bond market selloff that has challenged the integrity of the British financial system.

The central bank said on Tuesday that it would expand its program of asset purchases to include inflation-linked government bonds after a new move to bolster pension funds failed to calm markets. The bank said it would purchase up to £5 billion ($5.5 billion) of index-linked gilts daily through Friday. The bank increased the total daily amount of bonds it may buy to £10 billion on Monday.

According to the central bank, markets saw “a further considerable repricing of U.K. government debt” on Tuesday, particularly index-linked gilts, which shield investors from increasing inflation.

The BOE stated that “this market’s dysfunction and the potential for self-reinforcing ‘fire sale’ dynamics pose a danger to U.K. financial stability.”

According to Tradeweb, the yield on a 30-year U.K. inflation-linked bond increased from 0.851% on October 7 to 1.518%. The yield on the gilt was negative only a few weeks ago. Bond investors suffered painful losses due to the rising rates resulting from falling prices. After the BOE increased the purchases on Tuesday, the yields remained stable but at new, high levels.

On September 28, the central bank started buying bonds to assist pension funds with sizable positions in derivative-based assets negatively impacted by the spike in U.K. government bond yields. After the administration of Prime Minister Liz Truss announced significant, debt-financed tax cuts, borrowing rates increased.

The BOE’s bond purchases temporarily steadied the U.K. bond markets. Still, recent days have seen a resumption of the selloff since the size of the BOE’s interventions has persistently lagged behind market expectations. By this Friday, the BOE has committed to purchasing up to £65 billion in long-term bonds. It had acquired slightly over £5 billion in total as of Monday.

Due to its employment of a technique known as liability-driven investing, pensions have been at the epicenter of the U.K. instability. To earn enough money over time to pay back what they owed pensioners, defined-benefit pension plans in the United Kingdom started to use LDIs in recent years.

To increase profits, these techniques mix leverage and interest rate-related financial derivatives. Huge collateral requests on pensions were made due to the extraordinary movements in the U.K. bond markets last month to support the leveraged investments. To fulfill such demands, the pension funds have sold other assets, such as government bonds, which has increased the pressure on rates and had a domino effect on the markets.

Pension fund managers have recently encouraged the BOE to incorporate inflation-linked government bonds in its scheme. Most such bonds are often held by pensions, which helps shield the plans from fluctuations in interest rates and inflation.

The central bank was encouraged on Tuesday to extend its purchases from the current expiry date of this Friday to the end of the month by the Pensions and Lifetime Savings Association. This trade group represents the pension sector.

According to pension advisors, the introduction of inflation-linked bonds could help stabilize that market segment, which has grown challenging to trade due to limited liquidity. Pension funds that need more funds to cover margin calls may benefit from the BOE’s bond purchases.

“LDIs can raise money using a variety of different asset classes. According to the senior portfolio manager at Allianz Ravin Seeneevassen, the buyback only applied to conventional gilts. We could be at odds with how the LDI funds attempt to raise money.

The more extensive program on Tuesday hinted that previous attempts couldn’t stop the harm. The BOE introduced a lending mechanism for pension funds the day before through banks that would allow them to post a broader range of collateral than was previously possible, including inflation-linked gilts and corporate bonds in exchange for cash.

The fact that the government has not yet disclosed its borrowing plans for the upcoming years complicates the central bank’s efforts to restore the bond market. Those plans will determine the number of gilts that investors will be requested to purchase. On October 31, the U.K. Treasury secretary is anticipated to make plans public.

The third-highest fiscal year borrowing since World War II and £100 billion more than anticipated in March of this year, according to the nonpartisan Institute for Fiscal Studies, a think tank that focuses on the budget. The borrowing is expected to reach £200 billion in the fiscal year ending in March.

Happy
Happy
0 %
Sad
Sad
0 %
Excited
Excited
0 %
Sleepy
Sleepy
0 %
Angry
Angry
0 %
Surprise
Surprise
0 %
Previous post The Worst is Yet to Come, Lowered IMF Global Growth Prediction for the Upcoming Year
Next post Home Flippers are Hurt by the Sudden Decline in the US Housing Market.