Bank of England’s £65bn intervention saves the UK from a financial collapse, for the time being

For how long can a severe financial crisis be avoided?

The week before last, the Bank of England revealed that a £65 intervention kept Britain from the brink of financial catastrophe.

The Treasury gave a statement that the Bank of England was asked to outline critical events resulting in its intervention, why it was executed and what further consequences on monetary policy might be.

Deputy governor of the BoE, Sir Jon Cunliffe, said there was fear over the amount of disruption that would have otherwise happened to key funding markets and the resulting chain reaction from that financial instability. He pointed out that pension funds would have been hit hard — being pushed to sell at a rate of £50bn of assets into government bonds and a dizzied market. 

Market intelligence, he said, received by the Bank indicated increasing problems from varied markets and participants, notably with LDI fund managers, saying that the conditions in key markets, should things go on to worsen, would lead to managers having to dump large volumes of long-term gilts into an increasingly liquidating market.

Sentiments from said market intelligence implied that this would have led to an increased long-term dump of gilts at a minimum volume of £50bn in an acute time window, which dwarfs the current market averages; trading volumes of only £12bn daily in said sectors.

The liability-driven investment product, LDI, is popularly offered by fund managers to pension fund owners, operating through derivatives that assist them with “matching” assets and liabilities in order to eliminate the threat of shortfalls in capital being paid to pensioners.

In 2011, the LDI product was worth roughly £400bn, but this majority sector quadrupled to £1.6 by 2021, according to figures from Investment Association.

What would the effects have been without the intervention?

Reasons for this intervention explained in Cunliffe’s letter, mentioned that the gilt markets were unable to absorb such a high amount of sales in such a short stretch — if the dump had succeeded, yields would have cascaded further, prompting an avalanche of gilt sales from participants trying to maintain solvency. He forecasted that this would have led to spiralling gilt sales at dwindling prices, socially pressuring more fund managers to follow.

Threadneedle Street’s intervention on 20 September purportedly prevented grave amounts of pooled ODI funds from going to the negative for their net asset worth, triggering which would have triggered shortfalls of collateral linked to banking counterparties.

His response came as an answer to questioning from the Treasury committee chair, itself responsible for clarifying why the Bank developed the monetary policy of temporarily purchasing UK government bonds.

The programme outlined that it would buy up to £65 in gilts in just under two weeks, which itself was to respond to the tax-cut mini-budget. Finance minister,  Kwasi Kwarteng, revealed his plan to cut taxes by £45 billion — a policy that has that the Minister has reversed since — itself causing severely disrupted trading in the stocks and pound markets.

Requested by the Treasury was an explanation of key events behind the intervention, why it was essential, what permanent changes would remain on monetary policy, and how the effectiveness of the policy will be measured — when it would conclude.

The UK central bank concurrently agreed to buy almost £154 of long-dated gilts. But it rejected over £120 million of gilts, which is said was not needed to reach the level of stability sought.

The Bank is permitted to purchase up to £5bn of long-dated gilts on a daily basis.

Economic context: Strength of the pound slipping as US jobs data prompts wilting

The all-around situation is looking dire as the already bleak pound recently fell after a week of strengthening — or the self of October, it depreciated after showing some signs of strengthening.

The pound sterling reversed its course after stripping, dropping on Friday as traders anticipated raising interest rates Following the release of the US jobs report. The markets concluded that the Federal Reserve would have to raise interest rates for longer than expected, logically leading to the Bank of England also raising.

Payroll figures for non-farm increased by over 260k for September, climbing beyond the estimated 250k estimates, while the increase for August was 315k. This meant an unemployment rate of 3.5%.

Investors who wanted the Fed to reverse were left discouraged after the report, which indicated that the US economy was handling itself moderately well, says Chris Beauchamp, lead market analyst for IG interactive trading.

Beau said that the short-term growth of the pound was interrupted as traders forecasted at least 125 bps of restrictions by the end of 2022, with more into the following year.

The pound wilted by half a per cent and dropped by so 0.3% relative to the euro to €1.13. Meanwhile, your is nearing dollar parity once again — only two cents away.

The Fitch ratings agency meanwhile downgraded the UK government’s debt rating to “negative” in the same week, changing its status from “stable” in response to the new government's mini-budget cuts. The agency warned that the unfunded fiscal package was large enough to cause a substantial increase in government debt in the near future.

This view is that unfunded, big fiscal programs could irresponsibly spike deficits despite its ambitions to boost the economy. The UK government seeks to borrow £43 billion in an effort to promulgate growth.

Furthermore, Fitch predicted that the UK economy will contract by contract in 2023, regardless of the new Prime Minister’s and Chancellor’s mini-budget.

On the contrary, the ratings agency anticipates that the all-around government deficit will hit 7.8% of GDP in 2022 and then 8.8% the following year, with the general government deficit bouncing to 109% of gross domestic product by 2024.

The dwindling British pound has prompted concerns about the cost of borrowing, promulgating increased fears about how the wider markets will cope but this also comes at a time when a new report from Halifax revealed that the UK property market was also contracting — the price of housing dropped by 0.1% in September to, on average, £293,000.

The Halifax mortgage lender cautioned that the recent swell in mortgage costs will predictably add precious to the market.

The lender’s perspective on the situation was that house prices have been increasing due to a vigorous labour market, a low supply of British homes on sale, and reductions in stamp duties.

However, the recent increases in the cost of living, ever-increasing hikes in interest rates, and increased costs of mortgages are probably going to cool the market down further and lower the price of houses. This was according to the director of Halifax Mortgages, Kim Kinaird.

The backdrop — a hunger for resources

As oil prices surge in autumn, going into winter, the markets concerned themselves with the loss of Russian supplies after sanctions purportedly in response to the Ukrainian conflict.

The most recent meeting by OPEC+ reduced the availability of oil by 100,000 barrels per day in October. This did not have a positive impact on oil prices although it gave caution that it would step in if all prices kept dropping.