The Bank of England has expanded its emergency bond buying program to include inflation-linked government funds in its latest bid to stem ‘fire selling’ by pension funds that have created a “significant risk to the financial stability of the United Kingdom”.
The central bank said on Tuesday it was ready to buy up to £5bn a day of index-linked UK government bonds as it warned of a “dysfunction” in the gilt market. Its new intervention marks the first time it has purchased indexed debt as part of its bond-buying programs.
The latest measures, which were announced just before markets opened in London, come just a day after the BoE unveiled a new short-term funding package which it hoped would act as a relief valve for investors. pension schemes that have been caught in a vicious circle after Chancellor Kwasi Kwarteng’s ‘mini’ budget of September 23 triggered a historic gilt sale.
“Two interventions in 24 hours is quite extraordinary,” said Sandra Holdsworth, UK head of rates at Aegon Asset Management, adding that the BoE measures show how the problem in the pensions sector is “much bigger important than anyone thought a week ago”.
The BoE’s emergency bond buying program, which was launched on September 28, initially helped calm jittery markets. But sales rose sharply on Monday as analysts and investors worried about the program’s impending end date on Friday.
“The start of this week saw another significant repricing of UK government debt, particularly pegged gilts. The dysfunction of this market and the prospect of a self-reinforcing ‘fire selling’ dynamic is significant risk to the financial stability of the UK,” the bank said.
Inflation-linked gilts, a market dominated by defined-benefit pension plans, came under particularly acute selling pressure on Monday. The 10-year yield had jumped 0.64 percentage points to 1.24%, the biggest rise since at least 1992, according to Bloomberg data. Monday’s selloff set a gloomy tone ahead of a £900m 30-year inflation-linked gilt selloff by the Office of Debt Management due to take place on Tuesday.
Conventional gilts also suffered a fresh surge of selling pressure that took 30-year government borrowing costs to their highest level since the BoE announced its bond-buying program in September.
The BoE on Monday raised the limit on its daily bond purchases to £10 billion from £5 billion previously. It kept that overall cap intact on Tuesday, but said it would buy up to £5bn a day in conventional gilts and £5bn in pegged gilts until the program expires on Friday. So far, the central bank has used only a small fraction of the total £65bn it has allocated to bond purchases.
Markets stabilized after the BoE’s latest intervention, with the 10-year inflation-linked gilt yield falling 0.17 percentage points.
Pension funds are important players in the UK bond market, as they need to match their assets with long-term liabilities to their members. Private-sector defined-benefit pension plans had 72% of their assets invested in bonds as of March 31, 2021, including 47% in index-linked gilts, according to data from the Pension Protection Fund.
Defined-benefit pension plans have been at the center of the gilt turmoil, as many use liability-driven investing (LDI) strategies to match their assets and liabilities.
When gilts began to fall sharply following the September 23 ‘mini’ budget, which included £45billion in unfunded tax cuts, pension schemes provided additional safeguards for their LDI schemes.
Funds that lacked sufficient liquidity had to sell assets, creating a powerful selling spiral that weighed heavily on the gilt market and also affected other asset classes such as corporate bonds denominated in pound sterling.
The BoE on Monday set up a new lending facility that allows banks to offer a wider variety of collateral in exchange for short-term funding, in hopes this would trickle down to customers using LDI plans. Analysts said the new window would help ease the pressure, but feared longer-lasting intervention was needed to stabilize the market.
Additional reporting by Mark Wembridge