Gilt Market Carnage Prompts Risky Bank of England U-Turn


Life comes at you fast, particularly if you’re a central banker trying to keep calm and carry on in these febrile times.

Just two days after ignoring calls to intervene in the markets after Friday’s government tax giveaway trashed sterling assets, the Bank of England has decided moves in the gilt market have become sufficiently violent to warrant action. It’s a capitulation that could backfire badly.

With the 30-year UK government bond yield surging to almost 5.15% Wednesday, a climb of 150 basis points in a week, the central bank announced it will purchase an unlimited amount of long-dated debt “to restore orderly market conditions.” Gilts across the entire yield curveimmediately rallied.

The BOE also said it will delay sales of more than £800 billion of gilts accumulated during quantitative easing until the end of next month. It was supposed to start offloading its stockpile next week; the postponement is a tacit admission that it’s lost control of the gilt market — never a good look for a central bank.

What’s probably worrying the BOE is the prospect of a fire sale of assets by UK pension funds to meet margin calls as the value of their gilt investments has plummeted. Those funds have loaded up on long-dated debt to match their liabilities to policyholders, and may have attempted to juice their returns by dabbling in derivatives.

“For pension funds using swaps to hedge liabilities, collateral calls for margin payments will be large given the scale of the move in long-dated bond yields,” Jim Leaviss, a portfolio manager at M&G Plc, wrote in a blog yesterday. So far, so good; the BOE’s belated intervention has reduced the losses pension funds and other investors have suffered on their gilt holdings, which will ease those margin calls.

But it’s the outlook for monetary policy that matters most, and here the BOE may have left itself a hostage to misfortune. Last week, rate setters voted 5-4 to increase their benchmark by half a point to 2.25%, with three officials in favor of a larger hike of three-quarters of a point. In the wake of the government’s fiscal splurge, calls for an emergency rate hike to curb inflationary pressure and rescue the pound have grown.

The futures market is anticipating a 150 basis-point increase in the official interest rate by the time the BOE next meets on Nov. 3, and a peak of more than 6% by the middle of next year. At those levels, the housing market would probably crash and the economy would slide even deeper into recession.

The risk is that the BOE finds itself in a standoff with financial markets, with pressure increasing to hike borrowing costs before its next scheduled monetary policy meeting. After blinking on Wednesday, the central bank should resolve not to get bounced into tightening policy either prematurely or by more than the economy can bear.

More From Bloomberg Opinion:

• Can Kwasi Kwarteng Claw Back Credibility?: Raphael and Hanson

• Get Ready for the Great British Fire Sale: Chris Hughes

• Trussonomics Will Pinch UK Wallets and Wardrobes: Andrea Felsted

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. A former London bureau chief for Bloomberg News, he is author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

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