The UK cliff edge comes as the Bank of England prepares to end bond purchases

On September 28, the Bank’s Financial Stability Board announced a two-week emergency purchase program for long-term UK government bonds.

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LONDON — The Bank of England’s emergency bond-buying program ends on Friday, with traders remaining jittery as volatility in the UK bond market looks set to continue.

The central bank initially announced the two-week intervention in the long-term bond market on September 28 after being informed that a number of liability-driven investment (LDI) funds – held for retirement – were hours away from collapsing as UK government bond prices fell.

Market volatility was sparked by the UK government’s so-called ‘mini-budget’ on September 23, which triggered widespread backlash over billions of pounds of unfunded tax cuts, while spooking bond markets and Pound Sterling.

Finance Minister Kwasi Kwarteng will now present an updated medium-term fiscal plan on October 31, the same day the Bank of England plans to start selling gilts as part of its wider monetary tightening.

Kwarteng cut short a visit to the International Monetary Fund in Washington on Thursday and returned to Britain as the government meets to deal with the country’s economic crisis. Reports suggest that a u-turn of £43bn. of unfunded mini-budget tax cuts may be imminent.

The bank’s monetary policy committee then meets on November 3 to decide its next decision on interest rates, and chief economist Huw Pill has indicated that the country’s new fiscal framework will require a “significant” response from monetary policy as policymakers seek to curb the sky. high inflation.

Prime Minister Liz Truss’s government maintains its sole aim is to achieve annual GDP growth of 2.5 per cent, but the focus on fiscal support for the economy means Downing Street and Threadneedle Street are pulling in opposite directions, with the Bank of England trying to fasten the belt. to cool the economy and curb inflation.

The BOE pill also pointed out that the measures taken recently to ensure a well-functioning market and financial stability were intended to preserve the effectiveness of monetary policy, but should not be considered monetary policy measures per se.

Bond yields, which move inversely to prices, rose again on Wednesday after Bank of England Governor Andrew Bailey confirmed that the emergency support mechanism would be withdrawn on Friday, giving LDIs about 72 hours to consolidate their balance sheets. That gilding 30 years the yield reached 5% for the first time since before the bank’s historic intervention.

While the gilt turbulence is expected to continue at least until the government’s fiscal policy update, some economists expect the market to force more targeted assistance from the bank in the coming weeks.

“It is very likely that the Bank of England will resume redemptions because two and two do not add up to 22 – it is virtually impossible to painlessly eliminate the huge amount of negative-yielding bonds from pension fund balance sheets, so it is likely to be very difficult, that they will take targeted action and I would be cautious because the next one is the ECB,” said Daniel Lacalle, chief economist at Tressis Gestion.

“What we are experiencing today in Britain is likely to be repeated by Italy, France, Germany itself in the coming months.”

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Luke Bartholomew, senior economist at Abrn, noted the level of market uncertainty about the government’s ability to deliver a credible fiscal package at the end of the month, suggesting volatility could continue and force further bank interventions.

“It is clear that the bank is trying to dispel concerns about fiscal dominance, where it would be forced into more permanent operations to support gilt yields in response to the volatility and pricing caused by the government’s fiscal policy,” Bartholomew said in a note on Wednesday.

“While the bank certainly needs to reaffirm its independence and the primacy of its price stability mandate, it is far from clear how credible such statements are given the degree of vulnerability exposed in the gilt market.”

Other support measures continue

The temporary procurement program was only one of the three components of the bank’s support program.

Chris Lupoli, Price and Inflation Specialist in the UK at BNP Paribastold CNBC on Thursday that the Bank of England remains focused on temporary purchases that serve as a “backstop.”

“This is also exemplified by the different valuation approach they use in the auction compared to the approach of historical QE purchases based on monetary policy,” he said, pointing to the relatively low values ​​of daily purchases made by the bank until Wednesday.

“It is also reflected in the fact that they bought only a fraction of the total initial maximum envelope, although this is also a direct function of the low number of bonds being auctioned.”

Lupoli suggested the temporary purchases were an “additional tool in the BoE’s financial surveillance toolbox” and could be deployed again in the future in the event of a “similar market failure” that the bank sees as a threat to financial stability.

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Crucially, the other two additional measures – the extended temporary repo facility for collateral (TECRF) and the extended creditworthiness of collateral set for index-linked long-term repo transactions – do not end on Friday.

Lupoli pointed out that the TECRF, which aims to enable banks to help ease liquidity pressure on customers’ LDI funds via liquidity hedging operations, had been extended to non-financial corporate bonds above a certain credit quality.

“It is important to note that the ability to draw liquidity on this basis (for an initial period of 30 days which can be rolled over) will continue until 10 November 2022; in other words, this important liquidity generating channel, specifically targeted against pension fund assets, will continue beyond this Friday,” he added.

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