BoE expands emergency bond buying to inflation-linked gilts

The Bank of England has expanded its emergency bond purchase programme, pledging to buy up to £5billion of inflation-linked gilts per day after yields soared on Monday.

Citing a ‘material risk’ to financial stability arising from heavy Government bond selling, the bank said the purchases would begin today and run until the end of this week.

Ten-year inflation-linked gilt yields, which rise as bond prices fall, rose 64 basis points on Monday, hitting 1.24 per cent – the largest rise since at least 1992 – with some analysts blaming the sell-off on LDI pension fund investors forced to sell them alongside traditional government 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 a statement.

The pound fell in the wake of the announcement and is currently down 0.47 per cent to $1.1022.

Holders of gilts are concerned about what will happen when the BoE’s emergency intervention measures end on Friday.

The Chancellor is set to bring forward his fiscal plan to 31 October, from 23 November initially, as the Government hopes to reclaim credibility with international investors.

Monday’s inflation-linked gilt sell-off came despite the Bank of England’s initial intervention, which saw it commit to buying up to £10billion of traditional gilts per day.

Traditional gilt yields also rose on Monday but inched lower on Tuesday following the bank’s announcement.

‘The beginning of this week has seen a further significant repricing of UK government debt, particularly index-linked gilts,’ the BoE said.

‘Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to UK financial stability.’

Inflation-linked gilts are typically held by pension funds, which have been forced to raise cash by selling the assets after Chancellor Kwasi Kwarteng’s ill-fated mini-budget led to a rout in UK government debt, when investors were spooked by plans for large  debt-funded tax cuts.

Pension funds were forced to stump up emergency collateral in liability-driven investments (LDI), which use derivatives to safeguard against shortfalls in pension pots, after British government bond yields rocketed.

To halt freefalling prices, the BoE was forced to pledge to buy as much as £65billion of gilts.

Head of FX analysis at Monex Europe Simon Harvey said: ‘The latest news by the BoE hasn’t corresponded to a surge in the pound like it did back on 28 September.

‘In our view, this is because the latest news by the BoE suggests that their withdrawal of support to the bond market on Friday will be too premature given the level of bond market dysfunction.

‘In the absence of an extension to the BoE’s backstop, in a more robust form than a temporary repo facility, FX traders are likely taking a bearish position on the pound ahead of what could be further market turmoil heading into next week, especially as broader risk conditions remain under substantial pressure.’ 

In a statement, the Pensions and Lifetime Savings Association welcomed the BoE’s latest intervention on gilt market turbulence, which ‘put significant stress on the gilt market and resulted in rapid and spiralling collateral calls for some defined benefit funds using LDI strategies’.

It added: ‘Following this morning’s and yesterday’s statements by the Bank of England, we will further assess with our members whether they believe any additional actions are necessary to achieve orderly markets. 

‘However, a key concern of pension funds since the Bank of England’s intervention has been that the period of purchasing should not be ended too soon, for example, many feel it should be extended to the next fiscal event on 31 October and possibly beyond, or if purchasing is ended, that additional measures should be put in place to manage market volatility. 

‘With this in mind, we welcome that the Bank of England itself stated last week, that “it intends to unwind its gilt operation in a smooth and orderly fashion” and only “once risks to market functioning are judged by the Bank to have subsided”.’