BoE responds to Treasury Committee on expanded emergency bond buying

In a letter to BoE deputy governor Sir Jon Cunliffe on 11 October, Treasury Committee chair Mel Stride asked how the bank judged it necessary to expand its intervention in gilt markets.

Last Monday (10 October), the BoE announced a series of additional financial stability measures, including that it would extend its daily gilt purchases to include index-linked gilts.

In his response, Cunliffe wrote that these measures were intended to enable liability-driven investment (LDI) funds to address risks to their resilience from volatility in the long-dated gilt market, and support an orderly end to the gilt market operation that was announced on 28 September.

He said these additional measures were implemented in the light of information the central bank had received as it progressed with the operation.

In particular, Cunliffe said that Many LDI funds reported that the greatest selling pressure was likely to come in the week of 10 October as that is when they would have greater clarity from their defined benefit (DB) pension fund investors on the amount of capital that could be raised and the quantity of asset sales needed.

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Cunliffe also said that it had learned that, while DB pension funds had holdings of sterling and international corporate bonds that they were considering using to raise liquidity to inject capital into LDI funds, either by selling the bonds or by borrowing against them, some LDI funds were concerned about their ability to raise liquidity in that way given uncertain liquidity conditions in that market.

He said it was these concerns that led the BoE to launch its temporary expanded collateral repo facility (TECRF) to temporarily expand the range of collateral accepted in its regular lending facilities to include non-financial corporate bonds of credit quality broadly equivalent to credit ratings of Baa3/BBB- or above.

Index-linked gilts

Cunliffe said the bank had first been made aware of difficulties in the index-linked gilt market around the time of its 28 September announcement.

However, it said it was unclear at that point whether the LDI funds could complete their necessary rebalancing by raising capital and selling conventional gilts rather than index-linked gilts, including through the bank’s conventional gilt purchase operations.

As a policy matter, Cunliffe said the bank had never previously purchased index-linked gilts in its monetary policy operations due to a concern that, given the low levels of illiquidity in the index-linked market, purchases by the bank could compound pressures faced by pension funds.

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It said it had also been concerned that buying index-linked gilts could crowd out a key tool for managing inflation risk.

However, the deputy governor said that the BoE had decided to include them in its programme after market contacts started reporting that the behaviour of 30-year nominal yields had been to a large extent driven by dynamics in the inflation-linked market.

The bank added that the action on 11 October was therefore designed to temporarily absorb selling of index-linked gilts in excess of market intermediation capacity, which would have spilled over to the conventional market.