Bank of England strengthens emergency stimulus to help ease market turmoil

The Bank’s Financial Stability Committee on Sep. 28 announced a two-week emergency purchase program for long-dated U.K. government bonds. Bloomberg | Bloomberg | Getty Images LONDON — The Bank of England on Monday announced further measures to ensure financial stability in the U.K., building on its intervention in the long-dated […]

The Bank’s Financial Stability Committee on Sep. 28 announced a two-week emergency purchase program for long-dated U.K. government bonds.

Bloomberg | Bloomberg | Getty Images

LONDON — The Bank of England on Monday announced further measures to ensure financial stability in the U.K., building on its intervention in the long-dated bond market.

The Bank’s Financial Stability Committee on Sep. 28 announced a two-week emergency purchase program for long-dated U.K. government bonds — known as “gilts” — to restore order to the markets and protect liability driven investment (LDI) funds from imminent collapse.

The central bank announced on Monday that it would introduce further measures to ensure an “orderly end” to its purchase scheme on Oct. 14, 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 auction limit will be confirmed each morning at 9 a.m. local time, with Monday’s set at £10 billion ($11 billion).

The Bank will also launch a Temporary Expanded Collateral Repo Facility (TECRF), which will allow banks to ease liquidity pressures on client funds embroiled in recent market volatility. Following last month’s unprecedented spike in gilt yields, LDIs — which hold substantial quantities of gilts and are owned predominantly by final salary pension schemes — were receiving margin calls from lenders.

A margin call is a demand from brokers to increase equity in an account when its value falls below the broker’s required amount.

The TECRF will enable banks to run what the Bank called “liquidity insurance operations,” which will last beyond Friday’s deadline and ease pressures on client LDI funds.

“Under these operations, the Bank will accept collateral eligible under the Sterling Monetary Framework (SMF), including index linked gilts, and also a wider range of collateral than normally eligible under the SMF, such as corporate bond collateral,” the Bank said.

Thirdly, the Bank said it would be ready to use its regular Indexed Long Term Repo operations each Tuesday — which allow market participants to borrow BOE cash reserves for six months in exchange for less liquid assets — to further ease liquidity pressures on LDI funds.

“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.”

Short-term reprieve

The unprecedented spike in gilt yields, which came on the back of the new government’s controversial fiscal policy announcements on Sep. 23, led to Bank of England staff working through the night before launching its rescue plan on Sep. 28.

The Bank revealed last week that some LDI funds were hours from collapse the following morning, which would have sent shockwaves through the U.K. economy.

Bob Parker, advisor at CBP Quilvest, told CNBC Monday that the new measures would likely assuage market concerns in the short term, but “a number of major problems” remain going into 2023, the first of which is that the Bank of England will need to raise interest rates further.

“That obviously has implications for gilt yields, which then loops back into the structural problems with LDIs,” he added.

Aon: Pension fund gilt sell-off caused a spiraling effect

Parker suggested that U.K. regulators “underestimated” the leverage in these LDI funds, which leaves them exposed to collateral obligations and margin calls when yields rise suddenly.

He anticipates that gilt yields will rise further, with the 10-year already up more than 100 basis points over the last month.

“The reality is we still have negative real yields in excess of 5% with inflation trending at least for the next few months around 10%, and as a result … institutional demand and retail demand for gilts, I think, is going to remain very muted,” Parker said.

U.K. 30-year gilt yields rose to their highest since Sep. 28 on Monday, up more than 8 basis points on the day.

Finance Minister Kwasi Kwarteng will now set out his medium-term fiscal plan and independent budget forecasts on Oct. 31, more than three weeks before the previously scheduled date, the Treasury announced on Monday.

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