To Calm Markets, Bank of England Will Buy Bonds on ‘Whatever Scale Is Necessary’

The purchases are designed “to restore orderly market conditions,” the central bank said, after days of turmoil that followed the government’s plan for sweeping tax cuts and higher borrowing.

The Bank of England is taking steps to intervene in the financial markets after the announcement of an economic growth plan spooked investors.

By Eshe Nelson Reporting from London.

Sept. 28, 2022

The Bank of England intervened forcefully on Wednesday to relieve days of market turmoil after the new government’s fiscal plans sent borrowing costs soaring and the British pound sinking to record lows.

In an extraordinary intervention, the bank said it would undertake large-scale purchases of British government bonds in the coming weeks. In addition to bringing down interest rates, the move helped buoy the pound, whose weakening has added to the nation’s inflation worries.

“The purpose of these purchases will be to restore orderly market conditions,” the central bank, which is independent of the government, said in a statement. “The purchases will be carried out on whatever scale is necessary to effect this outcome.”

After the announcement, stocks on Wall Street registered their first gain in more than a week. British stocks closed up slightly.

Bond and currency trading has been roiled since the new Conservative government of Prime Minister Liz Truss announced last week that it would seek to bolster economic growth by cutting taxes, especially for high earners, while spending heavily to protect households from rising energy costs.

The program has drawn criticism from political rivals and many economists, partly because of the extensive borrowing it will require at a time of rising interest rates and high inflation.

The International Monetary Fund, which works to foster global financial stability and monetary cooperation, signaled its alarm on Tuesday when it urged the government to reconsider its plans. It characterized the program as “large and untargeted” and said it was likely to worsen inequality.

Rising Inflation in Britain

Inflation Slows Slightly: Consumer prices are still rising at about the fastest pace in 40 years, despite a small drop to 9.9 percent in August.

Interest Rates: On Sept. 22, the Bank of England raised its key rate by another half a percentage point, to 2.25 percent, as it tries to keep high inflation from becoming embedded in the nation’s economy.

Energy Bills to Soar: Gas and electric charges for most British households are set to rise 80 percent this fall, further squeezing consumers and stoking inflation.

Investor Worries: The financial markets have been grumbling with unease about Britain’s economic outlook. The government plan to freeze energy bills and cut taxes is not easing concerns.

But Treasury officials have given no indication that the government will reverse course, deflecting responsibility for the disruption in markets onto Russia’s war in Ukraine.

The Ukraine war and inflation have created challenges for governments and central bankers around the world this year, but the pound has performed particularly badly. Its recent declines make it one of the worst performers against the dollar.

Since the start of the year, the pound has declined about 20 percent against the dollar and about 6 percent against the euro.

Compounding the situation, the government’s sweeping fiscal plan — presented without an independent fiscal and economic assessment — sent investors fleeing from British assets. Traders inferred that the central bank would be forced to raise interest rates quickly, which pushed up short- and long-term borrowing costs, because the economic plans seemed likely to stoke economic demand and add to inflationary pressures.

The sell-off in British assets since Friday, when the government’s plan was announced, has particularly affected bonds with long maturities, the Bank of England said.

“Were dysfunction in this market to continue or worsen, there would be a material risk to U.K. financial stability,” it said in a statement. This would lead to a reduction of the flow of credit to businesses and households, it added.

It said bond auctions would take place from Wednesday until Oct. 14. The intervention has also forced the central bank to pivot off its intended course of selling bonds next week, after it bought them to support the economy through the pandemic.

The yield on 10-year British government bonds on Wednesday climbed as high as 4.59 percent — the highest since 2008 — before the central bank’s statement. This week, 30-year yields exceeded 5 percent for the first time since 2002.

After the announcement, bond yields dropped sharply, with the 30-year yield falling by more than a percentage point to just below 4 percent.

“We’ve seen a dramatic reversal, but this is hardly a well-functioning market,” said Richard McGuire, a strategist at Rabobank. “There’s very thin liquidity,” making trading difficult, he added.

Mr. McGuire, who has been a fixed-income strategist for nearly two decades, said he had not seen anything resembling the recent moves in British debt outside of “something phenomenal” like the eurozone debt crisis a decade ago.

The central bank’s statement on Wednesday had echoes of a promise in 2012 by Mario Draghi, then head of the European Central Bank, to do “whatever it takes” to save the euro, which had come under severe pressure in the markets.

The intervention in Britain came after a central bank committee had warned of the risks to Britain’s financial stability from disruption in the government bond market. There had been concern about how the sharp rise in bond yields would affect pension funds, which tend to be large holders of long-dated government bonds.

At issue was a strategy used by liability-driven investment funds, which manage some pensions and have £1.5 trillion in assets. As bond prices plummeted, the investment funds needed to provide more collateral and were forced to sell bonds to raise cash, cementing losses. With so many funds trying to sell bonds into an illiquid market, there was the risk of a downward spiral in prices of government bonds — leaving funds that used this investment strategy potentially insolvent.

The bank said it would buy bonds with maturities of 20 years or more and be willing to buy up to £5 billion per auction. On Wednesday, it bought just over £1 billion worth of bonds.

“The Bank of England stands ready to restore market functioning and reduce any risks from contagion to credit conditions for U.K. households and businesses,” the bank’s statement said.

The speed of the rise in bond yields had also disrupted Britain’s mortgage market, with some lenders pulling offers on new mortgages because they had become too difficult to price.

“A decision by the government to scrap some of the tax cuts, or to cut spending sharply, would help to alleviate the stress in” currency and bond markets, Samuel Tombs, an economist at Pantheon Macroeconomics, wrote in a research note. “But its actions to date have eroded confidence among global investors, which cannot be easily restored. Accordingly, a painful recession driven by surging borrowing costs lies ahead.”

The market turmoil and the central bank’s intervention reveal the extent to which the government’s plans are at odds with the bank’s monetary policy goals. The government is trying to quickly generate economic demand, while the bank is trying to cool it to lower inflation. Consumer prices rose nearly 10 percent in August from a year earlier, putting the inflation rate at levels unseen since 1982.

On Tuesday, Huw Pill, the chief economist of the Bank of England, said the government’s fiscal plans would be met with a “significant” response by officials at the Bank of England, who are scheduled to meet again in early November. Markets are betting that interest rates will rise above 5 percent early next year, from 2.25 percent.

Just last Thursday, the central bank said it would initiate its plan to sell bonds back to the market — a process called quantitative tightening — as it tried to end the long era of easy money in its fight against inflation. It had insisted there would be a “high bar” for the bank to deviate from the plan, which would over the next year reduce its holdings of bonds by £80 billion through sales and redemptions, to £758 billion. On Wednesday, the bank said it was postponing the start of sales until the end of October.

Even as the bank tried to differentiate between Wednesday’s effort to ensure financial stability and the bank’s monetary policy stance, the intervention risks worsening the confusion in markets about the central bank’s goals, Mr. McGuire said.

Among the questions, he said, are: “Are we trying to contain inflation? Are we pushing back against a fiscally expansive government? Are we undertaking quantitative tightening?” Or, alternatively: “Are we doing the opposite? Are we adding to the inflationary pressure? Are we simply going to keep buying more bonds?”

The lack of clarity, he said, “doesn’t seem to be a positive in terms of the outlook for U.K. assets.”

Eshe Nelson is a reporter in London, where she writes about companies, the British economy and finance. @eshelouise