Pension fund panic led to emergency Bank of England intervention

The Bank of England on Wednesday launched a historic intervention in the UK bond market to shore up financial stability, with markets in turmoil following the government’s new fiscal policy announcements. government.

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LONDON – Events Bank of England toss out a historic intervention to stabilize the UK economyannounced a two-week long-term bond-buying program and delayed the planned gold-plated sale until the end of October.

The move follows a massive sell-off in UK government bonds – known as “background bonds” – after the new government announced fiscal policy on Friday. The policies include a large amount of unreimbursed tax cuts that have drawn criticism globally, and have also seen British pound falls to all-time low against dollar in Monday.

The decision was made by the Bank’s Financial Policy Committee, the body primarily responsible for ensuring financial stability, rather than its Monetary Policy Committee.

To prevent “unwarranted tightening of financial conditions and reducing the flow of credit into the real economy, the FPC said it will purchase gilts of “any size necessary” within a short period of time. limited time.

The unusual Central Bank announcement spooked pension funds, with some of the bonds held inside them losing about half their value in a matter of days.

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In some cases, the drop was so dramatic that pension funds started receiving margin calls – a need from brokers to increase equity in the account as its value fell. below the broker’s requirements.

Long-term bonds represent about two-thirds of the roughly £1.5 trillion so-called Liability-Directed Investment funds, which are primarily leveraged and often use collateral. as collateral to raise cash.

These LDIs, owned by pension schemes of last resort, are at risk of falling into insolvency as LDIs are forced to sell more gilts, thereby lowering prices and driving asset value. their assets below their liabilities. Final pay, or defined benefit, pension schemes are common workplace pensions in the UK, providing a guaranteed annual income in retirement based on final salary same or average of workers.

In the urgent purchase of aged gilts, the Bank of England is offering sow price support and allowing LDIs to manage the sale of these assets and revalue gilts in a manner that is affordable. more orderly, to avoid market speculation.

The bank said it will start buying up to £5 billion in mature gilts (those with a maturity of more than 20 years) on the secondary market from Wednesday to October 14.

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The expected losses, which could eventually return the gold-plated price to where it was before the intervention, but in a less chaotic way, would be “fully compensated” by the UK Treasury.

The bank kept its target of £80 billion in gold-plating revenue a year and delayed the start of gilding sales on Monday – or tightened quantification – until the end of October. However, some economists say that this is unlikely to happen.

“There’s obviously a financial stability aspect to the BoE decision, but there’s also a funding aspect. The BoE probably won’t say it explicitly but the small budget has added £62 billion of gold-plated issuance for the year. This financial and BoE is on the rise, ING economists Antoine Bouvet, James Smith and Chris Turner explained in an article Wednesday.

“Once QT restarts, these concerns will re-emerge. It would be much better for the BoE to commit to buying bonds for longer than the two weeks announced and suspend QT for much longer.”

A central story emerging from the UK’s precarious economic situation is the apparent tension between a government loosening fiscal policy while the central bank tightens to try to contain high inflation. sky high.

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Robert Gilhooly, senior economist at Abrdn, said: “It makes sense to buy bonds back in the name of a functioning market; however, this policy action also raises the specter of wealth. Monetary aid could add to market sensitivity and force a change of approach,” said Robert Gilhooly, senior economist at Abrdn.

“The Bank of England remains in a very difficult position. The impetus to ‘twist’ the yield curve may have some merit, but this reinforces the importance of short-term tightening to watch out for accusations of fiscal dominance.”

Monetary domination refers to the central bank financing government spending directly, while fiscal dominance occurs when the central bank uses its monetary policy powers to support government spending. government assets, keeping interest rates low to reduce government debt repayment costs.

Extra intervention?

The Treasury said on Wednesday it fully supported the Bank of England’s course of action and reaffirmed Finance Minister Kwasi Kwarteng’s commitment to central bank independence.

Analysts are hoping that a further intervention from Westminster or the City of London will help ease market concerns, but until then, mayhem remains.

Dean Turner, head of eurozone and UK economist at UBS Global Wealth Management, said investors should keep an eye on the Bank of England’s stance on interest rates in the coming days.

The Monetary Policy Committee has so far not found it appropriate to intervene on interest rates before its next scheduled meeting on November 3, but Bank of England Chief Economist Huw Pill has suggested. Note that a “significant” fiscal event and a “significant” drop in the pound would require a “significant” interest rate move.

UBS does not expect the Bank to move on this, but is currently forecasting a rate hike to 75 basis points at its November meeting, but Turner said the risk is now tilted more towards 100 basis points. The market is currently pricing in larger gains between 125 and 150 basis points.

The strategist said the UK government has made the position of the Bank of England almost impossible.

“The second thing to watch would be changes in government sentiment. We have no doubt that the current market moves are the result of a fiscal event, not a monetary event. Monetary policy is trying to improve after the milk spill,” Turner said.

The Treasury has promised more updates on the government’s growth plan, including costs, by November 23, but Turner said there is now “every chance” for this to be carried forward or at least begins with the following announcements.

“If the prime minister can convince investors, especially overseas investors, that his plan is credible, then the current volatility will be reduced. Anything less , and there is likely to be more turmoil for the gold-plated market, and the pound, in the coming weeks.” he added.

Now what for sterling and gilts?

Following the Bank’s intervention in the bond market, ING economists expect the pound to be slightly more stable, but note that market conditions remain “tough”.

“Both a strong dollar and doubts over UK debt sustainability will mean GBP/USD will struggle to hold rallies to the 1.08/1.09 region,” they said. know in Wednesday’s note.

This proved the case on Thursday morning as sterling fell 1% against the greenback to trade at around $1.078.

Bethany Payne, global bond portfolio manager at Janus Henderson, said the intervention was “just plaster on a much broader issue.” She thinks markets will benefit from governments “blinking first” in the face of market backlash to their policy agenda, rather than central banks.

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“With the Bank of England buying long-term bonds and thus demonstrating a willingness to re-start quantitative easing when markets turn turbulent, this should provide some comfort to investors that Gold yields are coming back,” Payne said.

Coupled with a “relatively successful” 30-year gilt deal on Wednesday morning in which the total return was £30 billion compared with £4.5 billion issued, Payne suggested there is some “comfort in the future”. roof when available”.

“However, a rise in bank rates while also engaging in near-term quantitative easing is an unusual policy quagmire to navigate, and is likely to speak to a continuation of monetary weakness. currency and constant volatility.”

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