The rise in UK borrowing costs has prompted the Bank of England to act quickly to prevent a “material risk to UK financial stability.”
Amid market turbulence brought on by investor concerns over the UK’s budgetary and economic credibility, the Bank said that it is starting an emergency, time-limited bond purchase program in a mid-morning statement.
From today through October 14th, it will buy long-dated government debt worth up to £5 billion per day.
Rates on UK government debt soared to levels last seen in 1998, prompting the shock intervention, the second this week.
This morning, the yield on the 30-year UK gilt spiked to about 5.05 percent, while the benchmark 10-year gilt for interest rates in Britain also increased. Prices and yields follow opposite trends.
Due to the significant decline in gilt prices, creditors asked that liability driven investment (LDI) funds, which are stocked with UK government bonds and are used by pension managers, come up with the cash right once to make up for their losses.
The fire sale of long-dated bonds caused by these margin calls increased rates and forced the Bank to intervene before a vicious cycle began.
Due to their frequent use of heavy leverage, LDI funds would have increased yesterday’s volatility without the Bank’s intervention. LDI funds reportedly have £1 trillion invested in UK government bonds, which are frequently lent out to increase returns.
The Bank was compelled to intervene because, according to it, “there would be a serious danger to UK financial stability were dysfunction in this market to continue or intensify.”
“The goal of these acquisitions is to bring back stable market conditions. The acquisitions will be made on whatever size is required to achieve this result; the Bank continued.
After the markets were shaken by the government’s tax reduction and borrowing binge, the Bank has effectively been compelled to begin its quantitative easing strategy in order to stabilize them.
Analysts at RBC said the Bank’s intervention is a “necessary evil” but that “the root cause of the problem [is] the government’s ill thought through fiscal strategy”.
Rates on the 30-year bond tumbled to below four per cent after the statement, a whole daily percentage point move, which is extremely rare in bond markets.
The pound surged 1.4 per cent against the US dollar on the news and was down slightly against the euro.
