When is monetary policy not monetary policy? When there is a crisis, it seems.
The Bank of England has recently been buying back gilts in the cause of financial stability rather than quantitative easing. It unveiled further calming measures on Monday. These should mean the gilts market is even less likely to fall off a cliff edge amid more panic selling after the sovereign bond purchase programme ends on Friday.
The bank has only bought about £5bn of gilts so far from a possible total of £65bn. That suggests the dangerous exposure of pension funds to liability-driven investment is smaller than first thought.
The UK central bank is still not taking any chances. It will allow for larger purchases this week and introduce additional liquidity backstops. No one interprets this as a weaker commitment to fighting inflation, which matters crucially to Britain’s long-term financial health.
The BoE is doubling its maximum daily gilt purchases to £10bn for the rest of the week. It is creating a new liquidity scheme for banks with clients who use LDI, which includes derivative hedging against low interest rates. Rising rates recently triggered costly and destabilising margin calls.
Wobbly pension funds can park gilts and investment-grade corporate bonds in return for cash. Unlike gilt purchases, usage of the facilities will be balance sheet neutral for the BoE, says Paul Dales of Capital Economics.
Yields on 30-year gilt yields rose to just over 4.5 per cent on Monday, remaining below levels recorded during the panic. They have been marching upwards since BoE intervention began. Steadily lower UK bond prices would bolster the credibility of the bank.
Hearteningly, the UK bond market has been predicting long-term inflation moving in line with the US and Europe. But the bank still needs to start quantitative tightening.
Long gilts are unlikely to be part of those operations for now. Fortunately, the longest-dated gilts make up only about a tenth of the BoE’s £800bn of gilt holdings. There is plenty of scope for the bank to keep its promise of a smaller balance sheet.
The Lex team is interested in hearing more from readers. Please tell us what you think of the BoE’s latest measures in the comments section below.
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