Mini budget market turmoil partly triggered BoE emergency intervention, dep governor says

Market volatility that followed chancellor Kwasi Kwarteng’s mini budget last month partly forced the Bank of England to step in to stabilise UK debt prices and prevent a crisis in the pensions sector, one of its top officials said today.

After Kwarteng slashed taxes by £45bn and signalled a borrowing surge on Friday 23 September, the pound slumped against the US dollar and UK borrowing costs surged.

This turbulence continued into the new trading week, creating “very poor” market conditions, Sir Jon Cunliffe, deputy governor of financial stability at the Bank, said in a letter in response to Tory MP and chair of the treasury committee Mel Stride asking why the Bank stepped into the bond market last week.

Bonds sold off rapidly heading into last Wednesday, forcing rates above five per cent and to their highest level since 1998.

Prime minister Liz Truss and Kwarteng have blamed global financial conditions for the UK’s spiralling borrowing costs. However, Cunliffe said eurozone and US rates did not climb anywhere near the same rate as Britain’s in the aftermath of the mini budget.

UK debt costs have climbed faster than US and eurozone

Intense selling in the UK bond market pushed down the value of liability driven investment (LDI) funds’ – which pension schemes invest in to ensure they can pay retirees – portfolios, triggering a series of margin calls.

The early signs of a fire sale emerged, Cunliffe added, caused by LDI funds ditching bonds to raise cash quickly to pay off creditors.

“As a result, it was likely that these funds would have to begin the process of winding up the following morning,” he said.

Without the Bank’s emergency measure, there would have been a “self-reinforcing spiral of price falls and further pressure to sell gilts,” Cunliffe said.

The Bank estimates LDI funds have invested around £1 trillion pounds in the long-dated government bond market. Pension funds themselves were not at risk of collapsing, but LDI funds were.

To avert what the Bank last week in its intervention statement described a “material risk to UK financial stability,” it launched an up to £65bn bond buying programme to stop LDI funds disappearing.

“This led to a more than 100 basis point fall in 30 year gilt yields that day,” Cunliffe said.

The Bank has purchased zero bonds over the past two days, indicating it is unprepared to buy them from investors at any price. It has used around £3.5bn of the support package so far.

The emergency measure is scheduled to end on 14 October, but Cunliffe opened the door to it continuing if volatility returns.

“Once the purchase programme is complete, the operation will be unwound in a smooth and orderly fashion once risks to market functioning are judged by the Bank to have subsided,” he said.