Bank of England widens government bond purchases as it warns of financial stability risk
The Bank of England has widened its emergency bond-buying programme to include inflation-linked gilts in its latest attempt to stem “fire sales” by pension funds that have created a “material risk to UK financial stability”.
The central bank said on Tuesday it was prepared to buy up to £5bn a day in index-linked UK government bonds as it warned of “dysfunction” in the gilt market. Its new intervention marks the first time it has purchased index-linked debt as part of its bond-buying schemes.
The latest measures, which were announced just before the opening of markets in London, come just a day after the BoE unveiled a new short-term funding programme that it hoped would act as a pressure release valve for pension schemes that have been caught up in a vicious circle after chancellor Kwasi Kwarteng’s September 23 “mini” Budget set off a historic sell-off in gilts.
Pension funds are huge players in the UK bond market since they need to match their assets with long-term liabilities to members. Private-sector defined benefit pensions had 72 per cent of their assets invested in bonds as of March 31 2021, of which 47 per cent was in index-linked gilts, according to Pension Protection Fund data.
Defined benefit pension schemes have been at the centre of the gilt turmoil since many use liability-driven investing (LDI) strategies to match up their assets and liabilities.
When gilts began falling sharply in price following the September 23 “mini” Budget, which included £45bn in unfunded tax cuts, pension schemes kicked in additional collateral for their LDI programmes.
Funds that did not have sufficient liquidity needed to sell assets, creating a powerful spiral of selling that weighed heavily on the gilt market and also affected other asset classes such as sterling-denominated corporate bonds.
The BoE on Monday created a new lending facility that allows banks to offer up a wider variety of collateral in exchange for short-term funding, with the hope this will trickle down to clients using LDI plans. Analysts said the new window would help ease the pressure, but worried that a longer-lasting intervention would be needed to stabilise the market.
This story originally appeared on: Financial Times - Author:Tommy Stubbington
