Bank of England insists market support stops on Friday

The Bank of England has insisted that its support for the bond market will stop on Friday, following reports it could be extended if necessary. The pound fell by more than a cent against the dollar on Tuesday to its lowest rate since September 29, after the Bank of England governor warned pensions funds that they had three days to rebalance.

The central bank intervened for the second time in as many days to buy long-dated British government debt to prevent “fire sales” of pension fund assets. Governor Andrew Bailey said at the time there could be no further extension after the Friday deadline. “You have got to get this done,” he said.

However, the pound rallied slightly on Wednesday morning after a Financial Times report that the central bank had signalled privately to lenders that it was prepared to extend the emergency programme if necessary.

A central bank spokesman later repeated Mr Bailey’s warning that the regulator would end its programme of emergency bond purchases this week.

“As the bank has made clear from the outset, its temporary and targeted purchases of gilts will end on October 14,” the spokesman said on Wednesday. “The governor confirmed this position yesterday and it has been made absolutely clear in contact with the banks at senior levels.”

The central bank said other measures taken over recent days would be in place after Friday “to ease liquidity pressures on LDIs [liability driven investments]”.

Amid the uncertainty, the yield on Britain's 30-year bond, or gilt, rose back above five per cent and close to a 24-year peak.

Economic consultant Oxford Economics said on Wednesday that Mr Bailey's insistence that emergency support would end on Friday was “an unsustainable position” that it expected to be reversed quickly. “The muted sell-off in long-end gilt yields this morning [30-year yields are up 27 basis points currently] already seems to be pricing in a climbdown and the extension of support,” it said.

The developments come at a time when data showed that the UK economy unexpectedly shrank by 0.3 per cent in August, according to official figures.

Gross domestic product is estimated to have fallen by 0.3 per cent in August 2022, after growing 0.1 per cent in July 2022, data from the Office for National Statistics said.

July's figure was revised down from 0.2 per cent. Experts had been expecting economic growth to flatline in August.

Grant Fitzner, chief economist of the ONS, said the economy shrank in August with “both production and services falling back, and with a small downward revision to July's growth, the economy contracted in the last three months as a whole”.

Sanjay Raja, Deutsche Bank’s chief UK economist, said the government’s mini-budget was the “straw that broke the camel’s back”, triggering the financial turmoil. Mr Raja told the Commons Treasury Committee there was “absolutely a global component” to the issues but added that there was an “idiosyncratic UK-specific component”.

He said the “trade shock” because of Brexit was another factor. “You throw on the September 23 event, you have got a sidelined financial watchdog, you have got lack of a medium-term fiscal plan, one of the largest unfunded tax cuts we have seen since the early 1970s. It was kind of the straw that broke the camel’s back.”

The British currency slumped 0.85 per cent to 1.099 against the dollar in early trading on Wednesday as unease about the UK's finances continued.

It has since rallied, reaching 1.1060 at 10.50am UK-time. Earlier, the Pensions and Lifetime Savings Association, representing the industry, issued a warning against ending the bank's intervention into the bond market “too soon”.

It suggested it should be extended at least until October 31, when Chancellor Kwasi Kwarteng is due to explain how he intends to get the public finances back on track after his £43 billion ($47bn) tax giveaway.

Alternatively, it said “additional measures should be put in place to manage market volatility”. The central bank said it had moved to act as a sell-off in the UK government bond market posed a “material risk to UK financial stability”, after yields on long-dated gilts soared once more on Monday.

That was despite action by the bank and government to allay investor concerns. Threadneedle Street said it would now widen the scope of its bond-buying programme to include purchases of index-linked gilts — a type of UK government bond that tracks inflation.

On Monday, it doubled its daily bond-buying limit to £10bn, while Mr Kwarteng brought forward his new fiscal plan and independent economic forecasts to October 31 to try to calm turbulent markets.

“The beginning of this week has seen a further significant repricing of UK government debt, particularly index-linked gilts,” the central bank said. “Dysfunction in this market and the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to UK financial stability.” It said its latest efforts would “act as a further backstop to restore orderly market conditions”.

The move came as the Institute for Fiscal Studies think tank said Mr Kwarteng would have to find spending cuts of more than £60bn if he is to meet his target.

The bank intervened with emergency action on September 28 when the mini-budget market response caused the pound to tumble and yields on gilts to soar, leaving some pension funds close to collapse.

The market turmoil forced pension funds to sell gilts to avoid worries over their solvency. Investment banks made calls on LDI funds, which in turn called on pension funds, forcing them into a fire sale of gilts, driving prices still lower and yields higher, and creating a downward spiral.

The central bank laid bare the scale of the woes last week when it said its emergency programme helped the UK to narrowly avoid a market meltdown caused by concerns over Mr Kwarteng’s tax cut plans.

But gilt yields started to surge again due to fears over the government’s economic policies and worries that the October 14 deadline set by the bank for its bond-buying programme could trigger a return to pension fund woes.

In particular, index-linked gilts have picked up sharply, sparking the latest action to stabilise the market. The central bank also indicated other bonds had come under pressure and announced that it would pause its corporate bond sales this week. “The bank continues to monitor developments in financial markets very closely in light of the significant asset repricing of recent weeks,” it said.