BoE ‘cliff edge’ poses fresh risk for ravaged gilt market

LONDON: United Kingdom bond markets face a potential “cliff edge” when the Bank of England (BoE) exits the market at the end of next week, leaving traders to navigate a turbulent backdrop without the support of a buyer of last resort.

Longer-term gilt yields are already starting to creep higher as the Oct 14 end date for its bond-buying looms into view, partly as policy makers make it clear they are in no mood to simply prop up prices for traders.

So far, the central bank has used only a fraction of its £100bil (US$114bil or RM529bil) war chest to buy bonds directly, yet its very presence as a backstop has helped bring stability and prevent a full-blown crisis spurred by forced selling from pension funds.

Markets face a “potential cliff edge” once support is withdrawn, said Daniela Russell, rates strategist at HSBC Holdings Plc.

“Although long-end gilt yields are off the highs we saw before the BoE intervened, they are still high – and potentially at unpalatable levels for many pension schemes.”

That’s left analysts calling for other measures to further safeguard the markets from liquidity crises, such as a permanent backstop or new facility, or even a delay to the BoE’s plan to sell the bonds it accumulated under quantitative easing.

The bank’s intervention has also brought the government time to address the fundamental concerns over its policies that drove the market chaos in the first place.

While Chancellor of the Exchequer Kwasi Kwarteng’s U-turn on scrapping a tax for higher earners help soothe some nerves, concerns over how the government’s fiscal plan will be funded continue to weigh on gilts.

The yield on benchmark 30-year bonds has climbed over 60 basis points from a low on Monday.

The central bank has said it will buy £5bil (RM26bil) a day under its current plan, but it has only purchased a total of £3.7bil (RM19.4bil) in the first week of the plan, and bought nothing at all on Tuesday and Wednesday.

That pattern has forced the market to start to acknowledge the withdrawal of support.

Already, the sudden drop in long-end yields following the intervention has been partially reversed. On Tuesday, the yield spread between 10-year and 30-year bonds saw its largest increase on record as traders scrambled to adjust after the BoE announced the lack of any purchases.

That gives a clue of what may happen if the support is withdrawn at the end of next week, with further pressure on longer-maturity debt coming from the high levels of gilt issuance still tabled in to fund the UK’s expansive fiscal policy.

Still, some investors argue the BoE’s record of stepping in to calm market turbulence will act as a tacit promise that it will backstop future crises if needed.

“They seem pretty clear that they want to stop on Oct 14 – that this is a targeted measure and a time limited measure,” said Peter Goves, fixed income research analyst at MFS Investment Management.

The end of the BoE temporary intervention “need not be a market negative. I think the market has accepted that the BoE is there in times of dysfunction.”

Some investors are concerned that afflicted parties such as pension funds will not have had enough time to recover from the disruptions of last week.

HSBC’s Russell, who had predicted the initial plan, suggested the BoE consider a “new long-term backstop” to allow pension funds time to adjust. This includes a commitment to carry out purchases of long-dated bonds on whatever scale is necessary. — Bloomberg

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United Kingdom , bond , Bank of England


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