City braced for end of £65bn Bank of England bond market package

The City is bracing for the Bank of England to pull its £65bn emergency support package for the bond market tomorrow, but experts said volatility could be tamed by existing backstops supporting the pensions industry.

Britain’s debt market has been rocked by concerns over the government’s financial credibility after it launched £43bn of tax cuts and a borrowing spree at last month’s mini budget.

A few days after the mini budget, yields on the 30-year UK gilt hit their highest level in over 20 years, forcing the Bank to step in and buy bonds to tame falling prices.

Yields fell sharply today, with the 30-year UK gilt yield shedding as much as 40 basis points.

The steep fall in bond prices prompted liability driven investment (LDI) funds that pensions have invested in to ditch gilts to generate quick cash to creditors.

30-year UK gilt yield this year

That has sparked fears UK pensions could collapse and that volatility in the gilt market will erupt when the Bank leaves the market.

Governor Andrew Bailey has been criticised for failing to stagger the wind down of the package to ensure markets gradually get used to standing alone.

Experts said market disorder will be minimal. “There are a number of safety valves” that could release pressure tomorrow, Steve Webb, former pensions minister and now partner at LCP, told City A.M.

“If it gets tough tomorrow, some firms may turn to the employer. The second one is the Bank of England itself. While they may not u-turn on gilt buying, I don’t believe the Bank of England will stand by and watch the financial system implode,” he added.

Others predicted the Bank may be forced to come back to the gilt market.

“A lack of BoE intervention and plans for active gilt sales to begin later this month, you’d assume the market will remain under pressure – not least because it’s not clear that the issues facing LDI have been fully addressed,” James Smith, developed markets economist at ING, City A.M.

Q&A

Are pensions safe?

Yes. There are several buffers in place to ensure pensions are shielded from market volatility. Firstly, pension managers can ask employers to inject cash into funds to boost their cash levels. Second, there is the pension protection fund, which bails out defined benefit schemes if things get really bad. Thirdly, there’s always the Bank of England.

What could happen?

Markets may get worried about swallowing a rise in gilt supply caused by ongoing selling without the Bank of England as a backstop. However, that will only happen if liability driven investment funds have not wound down their positions over the past few weeks since the £65bn support scheme has been in place. But, analysts have said they’ve hardly been convinced LDI funds have sorted out their finances ahead of tomorrow. The big problem is that LDIs borrow money to maximise their investments, meaning if they are forced to keep ditching bonds, that could trigger a fire-sale that spreads to the real economy. That’s precisely what the Bank has been trying to prevent.

Will the Bank of England be forced into a U-turn?

Maybe. Depends how bad things get. If there’s a repeat of the surge in gilt yields across the curve we saw a couple weeks back that forced the Bank’s hand, it’s unlikely to sit by and let markets get out of hand. If the Bank does comeback, that wouldn’t look favourably on governor Andrew Bailey.