Bank of England Widens Emergency Bond Market Intervention

The Bank of England on Tuesday announced an expansion of its emergency bond-buying program as it seeks to calm the U.K.’s volatile bond market.

The central bank said it would expand its purchase of government bonds, known as gilts, to include inflation-linked bonds. These are similar to the U.S. government’s Treasury Inflation Protect Securities with their payouts linked to a U.K. retail price index.

The Bank of England said it would buy up to £5 billion of these index-linked gilts each day through Friday, equivalent to $5.5 billion. This doubles the size of the bond-buying program to £10 billion.

The central bank said it was acting because volatility in the market for gilts was creating “a material risk to financial stability.”

The bond market in the U.K. has been whipsawed by extreme volatility since the new government led by Prime Minister Liz Truss announced a so-called “mini-budget” that was seen as expanding the budget deficit. Initially, gilt prices crashed, driving up yields, on the expectation of larger deficits and the view that the Truss government’s approach to government financing was too unconventional and risked inflation.

This reportedly put U.K. defined-benefit pension funds under strain because many had employed a liability-driven investment strategy, or LDI, intended to ensure that their assets match their payment obligations. These involve buying long-dated bonds that match the long-term liabilities but put the funds at risk of showing shortfalls when interest rates rise. To cover that risk, the LDI funds by derivatives that rise in value when yields rise.

But these derivatives also require firms to post more collateral when yields rise. Typically, funds meet collateral calls with spare cash on hand or cash that can be raised in a matter of days or weeks. But with yields rising rapidly, fund managers were facing unusually large and immediate collateral calls and found they lacked spare cash. So they turned to selling their closest-to-cash like assets, gilts, including the inflation-linked gilts.

With so many funds attempting to sell gilts at the same time, prices collapsed and yields soared even higher. This created a firesale that triggered the Bank of England on September 28 to announce a short-term intervention in the market that sent gilt prices soaring and yields plunging.

But on Monday, the gilt market began to face renewed sell-off pressures, prompting an expansion of the intervention.

“The purpose of these operations is to enable LDI funds to address risks to their resilience from volatility in the long-dated gilt market. LDI funds have made substantial progress in doing so over the past week,” the Bank of England said. “However, the beginning of this week has seen a further significant repricing of U.K. government debt, particularly index-linked gilts. Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics post a material risk to U.K. financial stability.”