Bank of England doubles bond-buying limit amid pension fund fears
The Bank of England will double the value of the UK government bonds it can buy each day under the emergency scheme it launched to calm markets after Kwasi Kwarteng’s mini-budget.
Threadneedle Street was forced to intervene late last month amid a dramatic sell-off for long-dated government debt after the chancellor announced more than £40bn of unfunded tax giveaways directed at middle and high earners.
Pension funds managing vast sums on behalf of retired people across Britain came close to collapse amid the meltdown in the bond market, in a “doom loop” of selling pressure, before the Bank stepped in with a promise to buy up to £65bn of government bonds until 14 October.
In the final week of its operations, the Bank said it would increase the maximum value of bonds it could buy to £10bn a day from a current level of £5bn to ensure there was “sufficient capacity in the market” before the end of the scheme.
The central bank has so far bought only about £5bn in gilts over the first eight days of the scheme, significantly below a maximum limit of £40bn. However, it signalled it was “prepared to deploy this unused capacity” over the coming days to help ease the pressure in bond markets.
The yield on 30-year government bonds fell from a peak of about 5% on the day before the Bank’s intervention last month to just under 4%, although had steadily climbed back towards 4.5% in recent days.
It comes after yields – which rise as bond prices fall – surged by more than one percentage point in the wake of Kwarteng’s mini-budget.
Government bond yields across advanced economies have risen in recent weeks amid fears over sky-high inflation and rising interest rates from the US Federal Reserve. However, City economists have pointed the finger at the chancellor’s unfunded tax cuts for exacerbating the bond market sell-off in Britain.
The Bank’s deputy governor for financial stability, Jon Cunliffe, appeared to suggest last week that the biggest movements in UK markets came after Kwarteng’s unfunded tax promises were made.
As a result of the meltdown, pensions funds invested in liability driven investment (LDI) schemes faced pressure as the value of the bonds they had pledged for their hedging activities collapsed.
The funds faced rolling “margin calls” to raise the amount of collateral – assets pledged as security to back up a financial contract – which in turn led them to sell more bonds to cover the cash demands, in a self-reinforcing downward spiral.
The Bank said in addition to increasing the size of the bond-buying programme it would launch a facility to help commercial banks to support pension funds struggling to find buyers and sellers for assets.
Beyond the end of this week’s operations, it said it would work with the UK authorities and regulators to ensure the LDI industry operates on a more resilient basis in future.