Things are moving fast in the financial markets. On Monday the governor of the Bank of England, Andrew Bailey, put out what he hoped would be a calming statement. Within 24 hours it was clear words alone were not going to be enough. There was evidence of a run on pension funds that was forcing them into a fire sale of their assets.
As a result, Threadneedle Street has been forced to extend its policy response. In a “whatever it takes” moment, the Bank said it would buy an unlimited amount of government gilts to stem the market panic. This represents a U-turn for an institution that less than a week ago pledged to start running down its stock of government bonds, but the Bank was left with no alternative.
On Tuesday night, the interest rate – or yield – on any new long-term government borrowing had risen to 5% – the highest level since the global financial crisis of 2008. The rapid upward move in gilt yields had implications for mortgage rates, overdrafts, company loans and pension funds.
In the City’s money markets, traders were predicting that the Bank would need 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 has responded with a temporary and targeted round of quantitative easing (QE) – the bond buying programme that it originally launched in early 2009. The Bank bought more gilts after the Brexit vote in 2016 and again stepped into the market in response to the Covid-19 pandemic.
This is the fourth round of QE, and is intended to provide the government with some breathing space and avoid the need for an emergency increase in interest, although that may prove necessary anyway if the boost from buying gilts proves short-lived.
The Bank is certainly talking tough. The idea is that an open-ended commitment to buying gilts will drive their price up and their yields down. As the price of gilts rises, the interest rate on them falls.
Even the prospect of more QE was enough to send yields tumbling, and there is a reason for that. The UK has its own currency and that means the Bank can print as many electronic pounds as it likes to buy gilts. It has – in theory at least – unlimited firepower.
Threadneedle Street was clear about why its hand had been forced, noting that dysfunction in the gilt market – if left unchecked – would pose a threat to financial stability. This is undoubtedly correct. The risk was that the negative reaction to Kwasi Kwarteng’s mini budget would lead not just 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, the chief UK economist at Capital Economics, said, this is not necessarily the end of the market mayhem. “While this is welcome, the fact that it needed to be done in the first place shows that the UK markets are in a perilous position. It wouldn’t be a huge surprise if another problem in the financial markets popped up before long.”
The Bank will be hoping it has done enough to calm markets before its monetary policy committee meeting on 3 November and a fresh fiscal statement from the chancellor on 23 November. After the events of the past five days, both seem a long distance away.
