A worrying jump in bond yields on Monday has forced the Bank of England to double its potential support buying to a massive 10 billion pounds a day to try and correct what the central bank said was “dysfunction” in the markets.
Not only that but the bank warned, for the second time in 13 days of its concerns about the country’s financial system.
The bank said there was “the prospect of self-reinforcing ‘fire sale’ dynamics (that) pose a material risk to U.K. financial stability.”
And by using the word ‘dysfunction’ the central bank had focused on the sudden emergence of investor unwillingness to hold UK debt or any type or duration, especially UK government debt.
In other words, the Bank of England reckons a loss of confidence has emerged in financial markets in the creditworthiness of the UK government and its financial soundness.
The BoE has in effect been forced to make the same move into the market for a second time in 13 days to steady confidence in the sterling and the government’s financial standing – it’s an unprecedented intervention.
After issuing a detailed statement on Monday aimed at reassuring markets that its billions of pounds of support will remain in place when its conventional bond buying finishes up this Friday, the Bank of England shocked markets by issuing a second statement early Tuesday in London announcing that it would also be buying up to 5 billion pounds of indexed linked bonds (these are inflation adjusted bonds of varying durations).
That statement was not expected by bond traders and economists and is aimed at reassuring markets that the bank is in control after a nasty surge in long dated bond yields on Monday afternoon forcing up borrowing costs for the UK government.
The bank said the new bond buying program will reduce the amount of unsold index gilts (bonds) that are becoming available in the market but not finding buyers, a situation that emerged on Monday and forced long bond yields to jump sharply, especially late in the session.
The yield on the benchmark 30-year gilt (bond) jumped 0.317 percentage points to end around 4.697% on Monday.
That sharp rise in yields on Monday was a curious reaction to the bank’s first reassuring statement which revealed detailed support for the markets this week and from October 14 (Friday) onwards.
Included in Monday’s statement was news that collateral for the bond buying would be expanded to include corporate bonds denominated in sterling which have emerged as a growing problem for more and more companies and banks as they have proved to be hard to trade.
Then in its Tuesday statement the bank surprised traders and others alike by revealing plans to buy up to 5 billion pounds ($US5.51 billion) of index-linked gilts a day, starting Tuesday, to run alongside its purchases of up to 5 billion pounds of conventional long-dated bonds.
“These additional operations will act as a further backstop to restore orderly market conditions by temporarily absorbing selling of index-linked gilts in excess of market intermediation capacity,” the BoE said in its statement on Tuesday morning.
That’s central banker-speak for mopping up a growing amount of unsold bonds by offering to buy them from sellers worried about their positions and rising interest rates.
This second statement came 13 days after the bank’s original support statement on September 28 which was made when the UK financial system threatened to freeze as bond yields soared, the pound hit a record low of $US1.0327 against the greenback and the home loan market came to a halt as banks and other lenders cut off their lending activities as interest rates jumped.
The trigger was the market panic in bonds and currencies in the wake of the botched September 23 tax cut statement from the Truss government (part of which has now been reversed).
But the unfunded tax cuts and threat of a surge in UK government debt next year triggered the flight from UK gilts and other sterling denominated debt and from sterling itself in the biggest crisis for the UK financial system since the GFC.
Tuesday’s statement shocked because it seemed the Monday statement from the B0E had been what the market had been wanting.
The bank said in a statement on Monday said it was prepared to increase the daily auctions from now to Friday to guarantee there will have sufficient capacity for the final week of its bond purchase scheme.
At the same time, it will expand its existing market operations to cover the post October 14 end of its support to ensure there is enough liquidity present for pension funds and others to access if they need to raise cash quickly and for a short while only.
The central bank announced that it would introduce further measures to ensure an “orderly end” to its purchase scheme on Friday including increasing the size of its daily auctions to allow headroom for gilt purchases ahead of Friday’s deadline.
“To date, the Bank has carried out 8 daily auctions, offering to buy up to £40 billion, and has made around £5 billion of bond purchases. The Bank is prepared to deploy this unused capacity to increase the maximum size of the remaining five auctions above the current level of up to £5 billion in each auction,” the Bank said in Monday’s announcement.
The proposed increase of the auction limit to up to 10 billion pounds sterling ($US11.04 billion) from 5 billion pounds is part of additional measures unveiled to facilitate the orderly end of the scheme that was initiated September 28 to restore market functioning in long-dated government bonds and reduce contagion risks to credit conditions for households and businesses.
The central bank is also planning to launch a temporary expanded collateral repo facility (called the Temporary Expanded Collateral Repo Facility (TECRF) and put in place preparations to support a further easing of liquidity pressures for liability-driven investment funds through its regular indexed long-term repo operations (that’s buying and selling bonds to move liquidity levels each day in the financial system).
In the statement on Monday, the BoE said it would allow a broader range of collateral, including corporate bonds, to be pledged at its new short-term funding facility.
The Bank said it would be ready to use its regular Indexed Long Term Repo operations each Tuesday — which allow market participants to borrow cash from the BoE’s reserves for six months in exchange for less liquid assets — to further ease liquidity pressures on pension funds with LDI deals in place
“This permanent facility will provide additional liquidity to banks against SMF eligible collateral, including index linked gilts, and so support their lending to LDI counterparties,” the Bank said.
“Liquidity is also available through the Bank’s new permanent Short Term Repo facility, launched last week, which offers an unlimited quantity of reserves at Bank Rate each Thursday.”
