The Bank of England has unveiled measures to stave off rushed asset sales by pension funds as it seeks to steady UK financial markets, while the UK Treasury also sought to assuage markets by bringing forward a much-awaited fiscal plan to October 31.
In the wake of fears of a “cliff edge” when its emergency bond-buying programme ends on Friday, the central bank both loosened the rules for the £65bn scheme and announced longer-lasting measures in a statement before markets opened on Monday.
Soon afterwards, chancellor Kwasi Kwarteng confirmed he would bring forward his medium-term fiscal plan from its previously scheduled date of November 23 and would ask the independent Office for Budget Responsibility to provide fiscal and economic forecasts on the same date.
In a statement before markets opened on Monday, the BoE said it would increase the limit on its purchases of UK government debt this week and would launch a new short-term funding facility to address the liquidity crisis in the UK pensions industry.
The latest intervention comes during a turbulent period in UK financial markets following Kwarteng’s “mini” Budget on September 23, in which the chancellor announced £45bn in unfunded tax cuts.
The fiscal plans ignited a historic sell-off in UK government bonds, which in turn caused a crisis in the pension industry and prompted the BoE to set up its bond-buying scheme. Pension plans have been dumping a broad range of assets, including corporate bonds as a result of the gilt sell-off, putting intense strains on the market.
The BoE’s intervention succeeded in stabilising markets, but created tension within the central bank over whether it was now targeting lower gilt yields, bringing with it lower government borrowing costs. BoE officials insisted it was not a monetary policy action, even though it used the Bank’s monetary policy tool — quantitative easing — and deputy governor Dave Ramsden described it last week as “an operation designed to buy time”.
The new funding facility is designed to more clearly show that these measures are financial tools, rather than a form of monetary policy.
Kwarteng has also faced pressure to explain the financing of the tax cuts, a principal reason why bringing the date forward for his fiscal plan and the OBR forecasts may assuage markets.
The BoE said on Monday that it was prepared to increase the size of its daily purchases of UK government bonds in order to “ensure there is sufficient capacity for gilt purchases” before the programme ends on Friday. While the central bank can buy a maximum of £5bn in gilts a day during its intervention, over the first eight days it purchased a cumulative total of less than £4bn — meaning that it retains significant headroom for additional purchases if needed this week.
Steve Webb, a partner with LCP, the actuarial consultants, and a former pensions minister, said the increase in the gilt purchase limit “should help to reduce any risk of a ‘cliff edge’ at the end of the week when the current special measures are switched off”.
Despite Monday’s measures, long-term UK government borrowing costs continued to rise. The 30-year gilt yield climbed 0.14 percentage points to 4.5 per cent, its highest level since the immediate aftermath of the BoE’s initial intervention on September 28.
“I don’t really see the point in saying you’ll buy ten billion a day when you’ve only been buying a few hundred million up until now,” said Peter Schaffrik, macro strategist at RBC. “The real question the markets have is ‘How much are you actually willing to spend?’”
The Bank also announced a new short-term lending facility designed to ease strains on pension funds that use liability-driven investing strategies, which are at the centre of the market turmoil.
The sell-off in UK government bonds meant pension funds needed to rapidly sell assets such as corporate debt and property funds to make collateral payments to keep their LDI strategies in place, creating a vicious circle that created strains in the sterling-denominated debt market.
In its announcement on Monday, the BoE said it would allow a broad range of collateral, including investment grade corporate bonds, to be used in the new repo facility to “enable banks to help to ease liquidity pressures facing their client LDI funds through liquidity insurance operations”.
The repo market acts as a vital lubricant in movements of billions of dollars and euros. Banks and investors use the market to find cash for the short term, offering high-quality collateral such as government bonds in return.
Peter Chatwell, head of macro trading strategies at Mizuho, said the new facility would “reduce the need for LDI accounts to force sell to find liquidity, when they can borrow cash versus a wider range of existing collateral from the BoE”. He added that the “liquidity crisis [among funds using LDI] may be better addressed via this facility”.
Additional reporting by Josephine Cumbo and Delphine Strauss
