Bank of England strengthens emergency stimulus to help ease market turmoil

The Bank’s Financial Stability Board announced on 28 September a two-week emergency purchase program for long-dated UK government bonds.

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LONDON — The Bank of England announced on Monday further measures to ensure financial stability in the UK, building on its intervention in the long-term bond market.

The Bank’s Financial Stability Committee announced on 28 September a two-week emergency purchase program of long-dated UK government bonds – known as “gilts” – to restore order to markets and protect liability driven investment funds (LDI) from impending collapse.

The central bank announced on Monday that it will introduce additional measures to ensure an “orderly end” to its purchase scheme on October 14, including increasing the size of its daily auctions to make room for gold purchases ahead of Friday’s deadline.

“To date, the Bank has conducted 8 daily auctions offering to buy up to £40 billion and has made around £5 billion in bond purchases. The Bank is prepared to use this unused capacity to increase the maximum size of the remaining five auctions above the current level of up to £5 billion in each auction,” the bank said in Monday’s announcement.

The auction limit will be confirmed every morning at 9 local time, with Monday’s set at £10 billion ($11 billion).

The bank will also launch a Temporary Expanded Collateral Repo Facility (TECRF), which will allow banks to ease liquidity pressures on client funds involved in recent market volatility. Following last month’s unprecedented rise in gilt yields, LDIs – which hold significant volumes of gilts and are predominantly owned by final salary pension schemes – receiving margin calls from lenders.

A margin call is a demand by brokers to increase the equity in an account when its value falls below the broker’s required amount.

TECRF will enable banks to run what the bank called “liquidity insurance operations” that will last beyond Friday’s deadline and ease pressure on customers’ LDI funds.

“Under these operations, the bank will accept collateral eligible under the Sterling Monetary Framework (SMF), including index-linked gilts, and also a wider range of collateral than normally eligible under the SMF, such as corporate bond collateral,” the bank said.

Third, the bank said it would be ready to use its regular indexed long-term repo operations every Tuesday – which allow market participants to borrow BOE liquidity reserves for six months in exchange for less liquid assets – to further ease liquidity pressures on LDI funds.

“This standing facility will provide additional liquidity to banks against SMF-approved collateral, including index-linked gilts, thereby supporting their lending to LDI counterparties,” the bank said.

“Liquidity is also available through the bank’s new permanent short-term repo facility, launched last week, which offers an unlimited amount of reserves at bank rate every Thursday.”

Short-term postponement

The unprecedented rise in gilt yields, which came on the back of the new government’s controversial fiscal announcements on 23 September, saw Bank of England staff working through the night before launching its rescue plan on 28 September.

The bank revealed last week that some LDI funds were hours from collapse the following morning, which would have sent shockwaves through the UK economy.

Bob Parker, an adviser at CBP Quilvest, told CNBC on Monday that the new measures are likely to ease market concerns in the short term, but “a number of big issues” remain in 2023, the first of which is that the Bank of England will need to raise the interest rate further.

“Obviously that has implications for gilt yields, which then go back to the structural issues with LDIs,” he added.

Aon: Gold-plated divestment of pension funds caused a spiral effect

Parker suggested that UK regulators “underestimated” the leverage in these LDI funds, leaving them exposed to collateral obligations and margin calls when interest rates suddenly rise.

He expects that the yield from gilt will increase further Ten years already increased more than 100 basis points over the past month.

“The reality is that we still have negative real interest rates of over 5% with inflation trending at least for the next few months around 10% and as a result… I think institutional and retail demand for gilts will remain very subdued, Parker said.

United Kingdom 30 years gold-plated yields rose to their highest since September 28 on Monday, up more than 8 basis points on the day.

Finance Minister Kwasi Kwarteng will now present his medium-term fiscal plan and independent budget forecasts on October 31, more than three weeks ahead of the previously scheduled date, the finance ministry announced on Monday.

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