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Bank of England widen the scope of its daily gilt purchase operation to include purchases of index-linked gilts

ended 11. October 2022

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This morning, the Bank of England has announced that it will widen the scope of its daily gilt purchase operations also to include purchases of index-linked gilts, as it warned an ongoing rout in the gilts market poses a “material risk to UK financial stability”. Newspage asked FS experts for their views.

7 responses from the Newspage community

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On Monday, it was announced that the long-awaited fiscal plan and OBR report were going to be shared on 31st October rather than 23 November. However, this has done little to cool the Uk bond market. Trust and confidence need to be restored in UK Plc and the wording from the Bank of England highlights the severity of the situation. No central bank would use the term "material risk to stability" lightly. Volatility is likely to continue until 31st October when deep cuts are expected to balance the books and go towards repairing the damage caused in the past few weeks. The first few weeks of the new administration have been nothing short of a disaster in terms of the impact on markets.
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I question whether this latest action from the Bank of England will have any effect and it's arguably naive to believe that we will see an orderly end to its gilt purchase scheme. That said, Threadneedle Street has been put in an extremely difficult position by the Government's policy messaging and whilst, ordinarily, a backstop buyer feels supportive, this time it just feels desperate. Also, what stops the selling resuming once the back-stop is removed? The whole situation is a farce.
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Index-linked gilts had a very bad day on Monday, with yields rising by 64bps. The 30-year was down 16 percent on the day. These are illiquid bonds and just a few sellers can send prices crashing. The Bank of England has therefore been forced to include these in its bond buying programme. More generally, the Bank's intervention hasn’t really worked in stabilising the bond market after the loss of confidence following the government’s mini-Budget. Weak International markets haven’t helped, either. Unfortunately this is having a real impact on mortgage rates, the economy and people’s lives. The mini-Budget has triggered a phenomenal amount of uncertainty in markets.
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The Bank of England quite simply should not have to be buying Index Linked Gilts. Market demand for these usually outstrips supply so the fact they are having to buy them shows exactly how broken the market is. The Bank are desperately trying to put out fires that the Chancellor is lighting all over the City, but they are only just keeping on top of things by some very creative approaches. Can the mature adults please take control of the government's economic policy and quickly? Never in the field of governance has one man crashed so much with so few words.
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If Liz Truss really wants to channel Margaret Thatcher, she should note her famous saying, "You can't buck the market". The Bank of England can only do so much and its actions seem to be running out of steam. While U-turns on the 45% tax rate, involving the OBR and proposed spending reviews are a move in the right direction, Truss and Kwarteng will need to go much further, and much more quickly rather than rely on the Bank of England to bail them out.
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The response of the Bank of England underlines its flexibility when it comes to intervening in the bond market, which is good news. The not to good news is that it also shows how volatile the market is and the apocalyptic impact the Government's ill-thought out mini-Budget and unfunded spending have had on gilts. It also highlights the dangers of using derivatives in cautious markets, and begs the question what the FCA and PRA were doing to allow such financial weapons of mass destruction to be used on workers pension schemes.
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The Bank of England's quantitative easing measures benefit mortgage holders by pushing down gilt yields, with the intention of lowering the cost of borrowing. So, when UK pension funds that rely on LDIs were forced to sell down their positions when bond prices dropped (so they can continue paying people’s pensions with cash), the Bank of England had to step in to buy bonds and keep interest rates down. But be aware that this move is intended to buy the Bank of England time for them to institute additional measures to reduce the turmoil in the market. Eventually, the central bank will have to revert to quantitative tightening. Given the volatility in the economy and expectations of further interest rate hikes, mortgage holders will be waiting a lot longer before rates show any sign of decreasing. With affordability still an issue, remortgaging will prove to be expensive for hundreds of borrowers whose fixed-rate mortgages are close to expiry. However, those with longer fixed terms will need to weigh if it is worth paying the penalty now for early termination to avoid paying even higher rates later on, if rates continue to rise. For new homebuyers, the only way to secure a mortgage is to remain in their jobs, establish their creditworthiness and prepare a higher deposit. Avoiding unnecessary spending on non-essential goods and services would also stand them in good stead.