The Bank of England is set to buy bonds in a bid to address the recent market tumult. PHOTO: ZUMA PRESS
U.K. central bank is launching an effort to restore order to the market for gilts
By Paul Hannon – The Wall Street Journal
The Bank of England on Wednesday said it would buy U.K. government bonds with long maturities “on whatever scale is necessary” in an effort to restore order to the market after a large set of government tax cuts sent borrowing costs soaring.
The move caused an immediate reaction, with bond prices both in the U.K. and other markets rallying, sending yields lower. The U.K.’s benchmark 10-year government bond yields fell to 4.004% after the announcement, from 4.552% before, an outsize move for what is normally a staid corner of the market. The pound rallied at first against the dollar but then slid further to trade down around 0.6% to $1.066.
In a statement, the BOE also said it would postpone the sale of government bonds under a program of quantitative tightening that was intended to help bring surging inflation under control. The program was agreed by policy makers earlier this month and was due to begin next week, but has been delayed until Oct. 31.
The BOE said that in the days since the government’s announcement, U.K. asset prices have suffered a “significant” decline that could weaken the country’s financial system and economy if left unchecked.
“Were dysfunction in this market to continue or worsen, there would be a material risk to U.K. financial stability,” it said. “This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.”
The central bank ended purchases of gilts, as U.K. government bonds are known, in December last year, when it also began to raise its key interest rate in response to surging inflation. Until the recent turbulence in U.K. financial markets, it had expected to reduce its holdings of bonds over the coming years.
The U-turn by the central bank highlights the depth of concern about the U.K.’s financial markets after the government’s tax cut plans unveiled last week spooked investors, sparking a steep selloff in the pound and roiling debt markets. The government stimulus put it at odds with the central bank, which has been trying to tame inflation through higher interest rates.
As recently as Tuesday, Bank of England Chief Economist Huw Pill told investors that the central bank would press ahead with bond sales. The decision to delay the sales is another example of the way in which the government’s surprise tax announcement has complicated the central bank’s efforts to tame inflation.
The central bank said its purchases of gilts wouldn’t mark a reversal of its longer-term plans.
“These purchases will be strictly time limited,” the BOE said. “They are intended to tackle a specific problem in the long-dated government bond market.”
In a separate statement, the government said it would cover any losses the central bank faces as a result of its purchase and later sale of bonds.
“The Government will continue to work closely with the Bank in support of its financial stability and inflation objectives,” a spokesperson for the U.K.’s Treasury said.
However, the Treasury didn’t associate the sharp decline in gilt prices with the government’s tax announcement, which has pushed up borrowing costs, attributing it instead to the fact that “global financial markets have seen significant volatility in recent days.”
The BOE last announced new purchases of U.K. government bonds in March 2020, when worries about the cost of fighting the Covid-19 pandemic had pushed yields sharply higher. Following a “special meeting” of the nine-member Monetary Policy Committee, it announced the purchases of 200 billion pounds, equivalent to $215 billion, in bonds, bringing the total in its possession to £645 billion.
Wednesday’s move by the bank reflected deep concerns that the bond market selloff was spiraling into a deeper systemic crisis that threatens to hammer an already struggling U.K. economy.
Several banks in the U.K. have suspended or curtailed new mortgages in recent days, unable to adjust to the whipsawing changes in bond yields, which set a benchmark for lending through the economy.
The furious selloff in U.K. government bonds, meant to be among the safest assets around, spread pain among investors such as insurance companies and pension funds that prefer assets whose values change only in small increments from day to day. Shares in banks and insurers in the U.K. were among the biggest losers in the stock market on Wednesday.
Concerns that some financial institutions would be damaged by the moves may have played a role in the BOE’s decision to snap up longer-dated bonds.
Analysts say the fast moves in yields in recent days triggered margin calls on investments tied to U.K. government bonds. Investors often sell safe assets, including government bonds, to drum up the cash they need to post more margin—a form of collateral—against trades they make. The idea that they have margin calls on the safe assets themselves has created significant unease among investors and traders.
The U.K.’s financial troubles have become a global concern. The International Monetary Fund late Tuesday made a rare public warning against the U.K.’s spending plans. Ratings firm Moody’s Investors Service said the plan was a negative for the country’s standing with creditors.
Featured article licensed from the Wall Street Journal.