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Britain’s cliff edge arrives as the Bank of England prepares to end bond purchases

On 28 September the Bank’s Financial Stability Board announced a two-week emergency purchase program for long-dated UK government bonds.

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LONDON — The Bank of England’s emergency bond-buying program is coming to an end on Friday, with traders still on edge as volatility in the UK bond market looks set to continue.

The central bank first announced the two-week intervention in the long-dated bond market on September 28, after being informed that a number of liability-driven investment (LDI) funds ̵[ads1]1; held by pension schemes – were hours from collapse as UK government bond prices plunged.

The market volatility was triggered by the UK government’s so-called “mini-budget” on September 23, which led to widespread backlash over billions of pounds of unfunded tax cuts while spooking both bond markets and 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 has earmarked to start selling gold as part of its wider monetary tightening.

Kwarteng cut short a visit to the International Monetary Fund in Washington on Thursday and is flying back to Britain as the government convenes to address the country’s economic crisis. Reports suggest a reversal of the mini-budget’s £43bn of unfunded tax cuts could be imminent.

The bank’s monetary policy committee then meets on November 3 to decide the next move on interest rates, and chief economist Huw Pill has indicated that the country’s new fiscal framework will necessitate a “significant” monetary policy response as policymakers look to rein in the sky. high inflation.

Britain’s cliff edge arrives as the Bank of England prepares to end bond purchases

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

The BOE’s pill also highlighted that recent measures to ensure orderly market functioning and financial stability sought to preserve the effectiveness of monetary policy, but should not be considered monetary policy actions in themselves.

Bond yields, which move inversely to prices, rose again on Wednesday after Bank of England Governor Andrew Bailey confirmed that the emergency support mechanism would be withdrawn on Friday, giving LDIs around 72 hours to shore up their balance sheets. The 30 years gilded The yield reached 5% for the first time since before the bank’s historic intervention.

With gilt-edged turbulence expected to persist at least until the government’s fiscal policy update, some economists expect the market to force more targeted assistance from the bank in the coming weeks.

“It is very likely that the Bank of England will resume buying because two and two do not equal 22 – it is virtually impossible to wash out the huge amount of negative yielding bonds on pension fund balance sheets without serious pain, so it is very likely that they will seize in targeted ways and I would watch out because the next one is the ECB,” said Daniel Lacalle, chief economist at Tressis Gestion.

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

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Luke Bartholomew, senior economist at Abrdn, 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 could persist and force the bank to further interventions.

“It is clear that the bank is trying to dispel concerns about fiscal dominance, where it would be forced into more permanent operations to support gilt yields in response to the volatility and repricing caused by the government’s fiscal policy,” Bartholomew said in a note on Wednesday.

“While the bank certainly needs to assert 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 three components in the bank’s support package.

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

“This is also exemplified by the different valuation approach they take in the auctions compared to the approach of the historical monetary policy-based QE purchases,” he said, pointing to the relatively low values ​​of daily purchases made by the bank up to 10 p.m. Wednesday.

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

Lupoli suggested that the temporary purchases were an “incremental instrument in the BoE’s toolbox of financial supervision,” and could be deployed again in the future should an “analogous market dysfunction” arise that the bank considers a threat to financial stability.

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Crucially, the other two additional measures – the Temporary Extended Collateral Repo Facility (TECRF) and the extension of collateral for the indexed long-term repo operations – will not end on Friday.

Lupoli highlighted that the TECRF, which aims to enable banks to ease liquidity pressure on customers’ LDI funds via liquidity insurance operations, had been extended to include non-financial corporate bonds above a certain credit quality.

“Importantly, the ability to withdraw cash on this basis (in the first 30 days, which can be rolled out) until November 10, 2022; in other words, this important cash-generating channel, particularly aimed at the asset side of the pension funds, will continue beyond this Friday , he added.

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