Things move fast in the financial markets. On Monday, Bank of England Governor Andrew Bailey issued what he hoped would be a soothing statement. Within 24 hours, it was clear that words alone were not going to be enough. There was evidence of a run on pension funds forcing them to sell off their assets.
As a result, Threadneedle Street has been forced to step up its policy response. In a “no matter what” moment, the Bank said it would buy unlimited government gilts to stem the market panic. This represents a turnaround for an institution that less than a week ago pledged to start actively reducing its stock of government bonds, but the Bank had no alternative.
As of Tuesday evening, the interest rate – or yield – on all new long-term government borrowing had risen to 5% – the highest level since the 2008 global financial crisis. The rapid rise in gilt yields had implications on mortgage rates, overdrafts, business loans and pension funds.
In the City’s money markets, traders expected the Bank to raise interest rates from 2.25% to 6% – a level that would be ruinous for an economy already in the early stages of recession.
As a result, the Bank reacted with a new round of temporary and targeted quantitative easing (QE) – the bond buying program it had originally launched in early 2009. The Bank bought more gilts after the vote on Brexit in 2016 and again intervened in the market in response to the Covid-19 pandemic.
This was the fourth round of QE and is intended to give the government some much-needed breathing space and avoid the need for an emergency increase in interest, although this may prove necessary anyway if the blow inch of buying gilts proves to be short-lived.
The Bank certainly talks tough. The idea is that an open-ended commitment to buy gilts will drive up their price and drive down their yields. As the price of gilts increases, the interest rate on them decreases.
Even the prospect of further QE was enough to drive yields down, and there’s a reason for that. The UK has its own currency, which means the Bank can print as many e-books as they want to buy gilts. It has – in theory at least – unlimited firepower.
Threadneedle Street made it clear why its hand was forced, noting that the dysfunctional gilt market – if left unchecked – would pose a threat to financial stability. This is undoubtedly correct. The risk was that the negative reaction to the Kwasi Kwarteng mini-budget would not only lead to a housing market crash, but also make it much harder for pension funds and insurance companies to meet their liabilities. There was a very real threat of contagion.
As Paul Dales, chief UK economist at Capital Economics, has said, this is not necessarily the end of market chaos. “While this is welcome, the fact that this had to be done in the first place shows that the UK markets are in a perilous position. It would not be a big surprise if another problem were to arise in the financial markets. Before a long time.
The Bank now hopes it has done enough to calm markets ahead of a meeting of its monetary policy committee on Nov. 3 and a further budget statement from the Chancellor on Nov. 23. After the events of the past five days, the two seem a long way off.