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The British cliff comes as the Bank of England prepares to end bond buying

The British cliff comes as the Bank of England prepares to end bond buying
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The bank’s Financial Stability Committee on January 9 announced a two-week emergency purchase program for long-dated UK government bonds.

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LONDON – The Bank of England‘s emergency Bond purchase program concludes on Friday, with traders remaining tense as volatility in the UK bond market is expected to persist.

The central bank first announced two-week intervention in the long-dated bond market on January 9 after being informed that a number of liability-driven investment funds (LDIs) – held by pension plans – were hours away from collapsing as UK stock prices government bonds collapsed.

The market volatility was triggered by the The British government’s so-called “mini-budget” on 9. 23resulting in a widespread backlash over billions of pounds in unfunded tax cuts, while also spooking both bond markets and the US British pound.

Finance Minister Kwasi Kwarteng will now present an updated medium-term financial plan on October 27th. The same day the Bank of England was set to start selling gilts as part of its broader monetary tightening effort.

Kwarteng cut short a visit to the International Monetary Fund in Washington on Thursday and flew back to Britain as the government met to tackle the country’s economic crisis. Reports indicate that a U-turn on mini-budget’s £43bn unfunded tax cuts could be imminent.

The bank’s monetary policy committee will then meet on 3/11 to determine the next step on interest rates, and chief economist Huw Pill has indicated the country’s new fiscal framework will require a “significant” monetary policy response as policymakers trying to contain sky-high inflation.

The analyst expects serious problems if interest rates do not settle at a sufficiently high level

Prime Minister Liz Truss’ government claims its only focus is on achieving 2.5% annual GDP growth, but the focus on fiscal support for the economy means Downing Street and Threadneedle Street are pulling in opposite directions, with the Bank of England trying to tighten its belt to cool the economy and curb inflation.

The BOE’s pill also emphasized that recent measures to ensure proper functioning of markets and financial stability were aimed at preserving the effectiveness of monetary policy but should not be viewed as monetary policy measures in themselves.

Bond yields, which move inversely with prices, rose again on Wednesday according to the Bank of England governor Andrew Bailey confirmed this emergency relief mechanism be withdrawn on Friday, giving LDIs about 72 hours to shore up their balance sheets. That 30 years gold plated The yield hit 5% for the first time since the bank’s historic intervention.

With the turmoil in gilts expected to continue at least until the government’s fiscal update, some economists expect the market to force more focused support from the bank in the coming weeks.

“It’s very likely that the Bank of England will resume buybacks because two and two doesn’t equal 22 – it’s virtually impossible to wash out the massive amount of negative-yielding bonds on pension fund balance sheets without serious pain, so very likely that they will intervene in a targeted manner and I would be careful because the next one is the ECB,” said Daniel Lacalle, chief economist at Tressis Gestion.

“What we live in Britain today is likely to be emulated by Italy, France and Germany even in the next few months.”

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Luke Bartholomew, senior economist at Abrdn, pointed to the level of market uncertainty about the government’s ability to come up with a credible fiscal package by the end of the month and hinted that volatility could persist and force more intervention from the bank.

“The bank is clearly trying to allay concerns of fiscal dominance, where it would be forced into more permanent operations to support gilt yields in response to the volatility and repricing caused by the government’s fiscal policies,” Bartholomew said in a statement on Wednesday.

“While the Bank certainly needs to reaffirm its independence and the primacy of its price stability mandate, it is far from clear how credible such statements are given the extent of the gilt market’s vulnerability.”

Other support measures continue

The temporary purchase program was just one of three components of the bank’s support package.

Chris Lupoli, UK rates and inflation strategist BNP Paribastold CNBC on Thursday that the Bank of England remains focused on the temporary purchases that serve as a “backstop.”

“This is also illustrated by the different valuation approach they use at the auctions compared to the historical QE monetary policy purchases approach,” he said, noting the relatively low readings of the bank’s daily purchases through Wednesday.

“This is also reflected in the fact that they only bought a fraction of the total initial maximum throughput, although this is also a direct function of the small number of bonds offered at the auctions.”

Lupoli suggested the temporary purchases are an “additional tool in the BoE’s financial supervision toolbox” and could be reinstated in the future should an “analogue market dysfunction” emerge, which the bank sees as a threat to financial stability.

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Crucially, the other two additional measures — the Temporary Expanded Collateral Repo Facility (TECRF) and the extension of the collateral eligibility set for the indexed long-term repos — do not end on Friday.

Lupoli stressed that the TECRF, which aims to allow banks to ease liquidity pressures on customer LDI funds through liquidity insurance operations, has been expanded to include non-financial corporate bonds above a certain credit quality.

“Importantly, the ability to withdraw cash on this basis (for an initial 30 days that can be rolled over) will be extended until 10 this Friday,” he added.

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