Bank of England responds to Treasury Committee’s questioning over bond buying intervention

John Cunliffe, deputy governor for the Financial Stability for the Bank of England, responded to a letter sent by the chair of the Treasury Committee Mel Stride yesterday (5 October), requesting details of the temporary gilt purchasing programme it carried out last week.

On 28 October, the central bank announced it would begin a temporary scheme of buying up to £5bn in long-dated conventional gilts until the 14 October 2022, triggered by a “significant repricing of UK and global financial assets” in the fall out of the government’s latest fiscal policy announcement.

The Bank of England has continued a cautious approach to gilt buying as part of its temporary market intervention, purchasing just £22m in bonds on Monday (3 October) and none on Tuesday.

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In his initial letter, Stride specifically asked the Bank to explain what had happened in the lead up to the intervention, how they judged that this was the necessary action to take and how did they determine the “appropriate scale”, what implications this had to other monetary policy, and how would it determine whether the intervention had been a success.

In his response, Cunliffe said that this was the first time the central bank had intervened in the gilt market “in pursuit of its statutory financial stability objective”. He said that Bank staff had worked “through the night” when needed to “design an intervention to address the problem”.

Cunliffe said all of this was done to “restore core market functioning and reduce the material risks to financial stability and contagion to credit conditions for UK households and businesses” and claimed it had acted in line with statutory financial stability objective to protect and enhance UK financial stability.

Running through the course of events, Cunliffe said the Bank had been monitoring market developments closely for several months as “the worsening global economic outlook had caused markets to be volatile in recent months”.

It said that when the BoE announced its most recent interest rate hike on 22 September, sterling was “broadly stable” and long-term gilt yields rose by around 20bps that day.

Sterling plummeted when the chancellor unveiled his Mini Budget on 23 September, and long-term gilt yields rose by 30bps over the course of the day.

“Liquidity conditions were very poor,” Cunliffe said. “Market intelligence calls identified the first concerns from liability-driven investment (LDI) fund managers about the implications of market developments, should they persist.”

This deteriorating economic and financial picture for the UK persisted and Cunliffe said the Bank monitored its developments closely, as its governor Andrew Bailey had publicly stated.

Bank of England continues cautious approach to gilt buying

Cunliffe said on 26 September that it had received reports from LDI fund managers, who said that conditions in core markets, should they continue to worsen, “would force them to sell large quantities of long-term gilts in an increasingly illiquid market”.

The next day reports continued to become more negative, and a meeting was convened with the Financial Policy Committee (FPC) to “view to the material risks to UK financial stability”.

“The Bank was informed by a number of LDI fund managers that, at the prevailing yields, multiple LDI funds were likely to fall into negative net asset value. As a result, it was likely that these funds would have to begin the process of winding up the following morning,” he said.

Cunliffe explained that these “unprecedented” moves in gilts has eroded the “cushion” LDI funds would normally have to sell its assets. He said they would have been forced to sell into an illiquid market or ask DB pension funds to provide more capital.

If the Bank had not intervened, a number of LDI funds may have defaulted, he said, which would have “amplified the stresses on the financial system and further impaired the girl market” since a large quantity of the gilts are held by banks as collateral.

“[This] would have forced other institutions to sell assets to raise liquidity and add to self-reinforcing falls in asset prices,” he noted. 

“This would have resulted in even more severely disrupted core gilt market functioning, which in turn may have led to an excessive and sudden tightening of financing conditions for the real economy,”

Given gilts yields have come back down and sterling has stabilised Cunliffe wrote that given the gravity of the event the bank had been willing to “carry out at whatever scale is needed to restore market functioning” and had judged that £5bn a day was “more than sufficient”.

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He said once that once the BoE judges that the risks to market functioning are gone, it will unwind the programme “in a smooth and orderly fashion”.

Discussing the implications this has on upcoming monetary policy, Cunliffe said that this bond buying was “designed to be temporary and targeted”, meaning it was “not intended to create central bank money on a lasting basis, nor are they designed to cap or control long-term interest rates”.

As such, they should not shift the underlying monetary trends in the economy, he said, which is will rely on to control inflation and a full assessment of recent macroeconomic events will be review ahead of the next MPC meeting on 3 November.

Cunliffe said that the Bank was still “monitoring the impact of the operations on market functioning” and “closely monitoring the progress of LDI funds”.

“While it might not be reasonable to expect market participants to insure against all extreme market outcomes, it is important that lessons are learned and appropriate levels of resilience ensured.”