Bank of England "panics" and rushes in to shore up bond instability

(Alliance News) - The Bank of England took the severe step on Wednesday of announcing it will carry out temporary purchases of long-dated gilts, in a "panicked" move.

Hargreaves Lansdown analyst Susannah Streeter said the decision is a policy u-turn and "smacks of a bit of panic and also of frustration that the government appears to be digging in its heels."

The pound was lower after the announcement, but the UK government's 30-year bond yield retreated to 4.44%, having hit a 1998 peak at 5.14%, and slipped even further to 4.04% as the session dragged on. The yield was sitting around 4.95% before the London equities market opened on Wednesday.

Against the dollar, the pound was trading at USD1.0733 on Wednesday afternoon in London, down versus USD1.0750 around the same time on Tuesday. It hit an intraday low of about USD1.0544 after midday.

The central bank said the purpose of the "purchases will be to restore orderly market conditions" after UK government bonds were significantly affected by "repricing".

The purchases, which will start on Wednesday, will be carried out on "whatever scale is necessary to effect this outcome."

The bank confirmed that the purchases will be "strictly time limited" and "fully indemnified by HM Treasury", referring to the UK government.

"The Bank of England is now pursuing a topsy-turvy set of policies, unleashing a fresh bond buying spree to try and bring down punishing rates – while at the same time still signalling it will aggressively hike interest rates to try and rein in runaway inflation," Streeter, senior investment & markets analyst at Hargreaves Lansdown, said.

Streeter noted this puts the central bank "in a bind".

"It knows ultra-high bond yields will cause a ricochet of problems for companies and consumers and potentially cause instability in the housing market but it's also very worried that the tax cutting spree will could cause inflation to rise to dangerous levels," she added.

Joshua Raymond of XTB.com said the move saw an immediate fall in long dated UK gilt yields with the 10-year and 30-year bond yields falling by around 0.4% in a matter of minutes.

He added: "This means it's now much more likely we will see major interest rate hikes before the next MPC meeting in November. Yet on the other hand, the Bank of England is applying plasters on the financial wounds created by the Truss government, who have shown no hint at reversing policy. So until that happens, the question remains how much further will the BoE be forced to intervene further and over what time period? Time will tell."

Justifying the decision, the Bank of England said that continued dysfunction would be "a material risk to UK financial stability". The BoE's Financial Policy Committee promoted the plan on the grounds of "financial stability".

AJ Bell investment director Russ Mould said Wednesday's drastic move highlights how much trouble the central bank is in.

"Although the bank has repeated its commitment to this plan today, the need to intervene shows how difficult it is going to be for Old Lady of Threadneedle Street to tighten policy rising rates and shrinking its balance sheet, while also trying to shelter the UK from the danger of recession as those higher interest rates dampen economic activity as well as managing volatility in the stock, bond and currency markets," Mould said.

The central bank's interest-rate setting Monetary Policy Committee clarified that although its annual target of an GBP80 billion stock reduction is "unaffected and unchanged", the beginning of gilt sale operations has been postponed to October 31. It reaffirmed that it "will not hesitate to change interest rates by as much as needed to return inflation to the 2% target".

Yields on gilts widened, and the pound plummeted to its lowest level ever against the dollar, after Chancellor Kwasi Kwarteng unveiled a series of unfunded tax cuts on Friday last week.

Berenberg Senior Economist Kallum Pickering said: "Gilt yields may be volatile in coming days as the BoE wrestles with market forces to stem selling pressure. But the BoE is the ultimate backer of sterling-denominated paper. Betting against its ability to fix the market disorder - at least in the short term - is futile, in our view.

"But to make the situation sustainable, the government needs to fix its own problems. On November 23, Chancellor Kwasi Kwarteng will unveil more of his fiscal plans. He should recognise that the recent disorder reflects perceptions about his and his government's credibility and take decisive steps to shore up confidence."

By Paul McGowan; [email protected]

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