The Bank of England is scrambling to contain a crisis triggered by the UK government’s impetuous plans to borrow massively to pay for tax cuts, fueling fears that the country’s financial markets could once again spiral out of control.
Almost 20 days after Finance Minister Kwasi Kwarteng unveiled his much-criticized plan to revive the economy, sparking an investor revolt, the UK bond market and sterling remain under pressure – despite three emergency interventions of the central bank.
Yields on benchmark UK 10-year government bonds climbed above 4.59% on Wednesday, close to where they were immediately after Kwarteng’s announcement last month. The yield on 30-year bonds also climbed above 5%. Yields rise as bond prices fall, driving up the cost of borrowing for government, mortgage holders and businesses.
The country’s central bank is in a difficult position. He is trying to restore the UK government’s lost credibility in the markets, although his toolkit is not designed for this type of effort.
“There’s nothing they can do to get to the root of the problem, which is confidence in UK assets,” said Richard McGuire, head of rates strategy at Rabobank.
Yet after the additional market support announced this week fell flat, the Bank of England is facing calls to do more to help stave off another meltdown. The focus is now on whether to extend the £65bn ($72bn) bond-buying program it announced in late September beyond its Friday end date.
pension funds who were hit hard by the UK bond market rout two weeks ago say they may need more time to put their house in order, and questions over the government’s plans to manage its debts – a key cause of the uproar – will not be answered until at least the end of October, when Kwarteng releases further details of its tax and spending plan.
“The only solution for the Bank of England now is to extend [bond-buying] a little longer and to make it bigger,” said Bryn Jones, head of fixed income at Rathbones. “The market turned around and said, ‘We need you to do more. “”
The Governor of the Bank of England, Andrew Bailey, is not moving, at least for the moment. “You have three days left now,” he told pension fund managers on Tuesday, stressing that the program was temporary. “You have to do this.”
The Bank of England said it had been forced to act to prevent a ‘self-sustaining spiral’ after the market saw unprecedented selling following budget plans revealed by Kwarteng and Prime Minister Liz Truss .
As the price of government bonds crashed, some pension funds were asked to provide billions of pounds in collateral. In a race for cash, investment managers were forced to sell whatever they could, including, in some cases, more government bonds. This sent even higher yields, triggering another wave of collateral calls.
The announcement by the central bank on September 28 that it would buy bonds until October 14 initially calmed the chaos. Still, market conditions have started to deteriorate again in recent days, with pension funds selling what they can to fill their coffers before the program ends.
“There is a good degree of pressing activity in the industry at the moment,” said Steve Delo, chairman of PAN Trustees, which provides governance services to UK pension schemes. “Investment consultants work feverishly.”
Ongoing bond market volatility further complicates these efforts, as rising yields again put hedging strategies in jeopardy.
“You have to face a moving target, and that’s probably the essence of the challenge,” Delo said.
So far, the Bank of England has only bought £8.8 billion ($9.8 billion) of bonds, well below what it could have collected.
But he was determined to meet Friday’s deadline, stressing that he does not want to intervene any longer than necessary.
“As the bank has made clear from the outset, its temporary and targeted purchases of gilts will end on October 14,” a spokesperson said Wednesday.
Yet, as bond yields continue to climb, not everyone is convinced that this approach makes sense. The Pensions and Lifetime Savings Association said the end date was a “major concern” for its members, who provide retirement income to 30 million people. Investors, meanwhile, have not been convinced of the steps taken so far.
“The BoE appears determined to show that the actions it is taking are financial tools, not a form of monetary policy,” Daniela Russell, head of UK rates strategy at HSBC, said in a recent note. to customers. “In doing so, however, we believe they may prove insufficient and fail to achieve their objective.”
The central puzzle is that the bank is caught in a web of conflicting political objectives. The British government has said it wants to boost demand to boost growth, while the central bank wants to reduce demand to bring down painfully inflation – creating confusion as to which objective will prevail.
Recent policy reversals by the battered Truss government, including the removal of a tax cut for high earners, have also made it difficult for investors to discern which measures are still in effect.
“The more you turn around, the more there is a question mark over the sustainability of any policy,” said Rabobank’s McGuire, who described the UK market situation as a “slow car crash”. .
Additionally, the Bank of England plans to start selling government bonds bought during the pandemic at the end of the month to help fight inflation. If he were to buy bonds at the same time to maintain market stability, his message could become even more confusing.
Russell said the situation remains “precarious”, but she believes the Bank of England can kick off bond sales as planned, provided it focuses on shorter-term debt, which has not was also badly hammered.
Such complex proposals show how awful the position of the Bank of England is. His past interventions have not worked. The government is making life difficult. And inflation, as always, continues to loom.
It’s a warning to governments around the world about the cost of any missteps at a delicate time, with interest rates rising at the fastest pace in decades and financial markets showing signs of strain.
What is happening in the UK is a “cautionary and salutary story”, said McGuire.