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BoE expands support for bond market to prevent rout

Expand the types of collateral it accepts in its existing Sterling Monetary Framework to include index-linked gilts and corporate bonds…reports Asian Lite News

The Bank of England stepped up its support for the UK bond market, aiming to prevent a rout in a $1 trillion part used by the pensions industry from spreading.

The move is designed to bring an orderly finish to emergency purchases at the end of this week and to provide longer-term support for a wider range of securities in the coming weeks.

The measures may give a boost to corporate credit, which has seen demand plummet along with other sterling-denominated assets since the Prime Minister Liz Truss’s government set out a series of tax cuts that spooked investors.

“The measure itself will be positive near term,” said Bob Stoutjesdijk, a fund manager at Robeco Institutional Asset Management.

UK bonds were initially steady after the announcement, before edging lower. The 30-year yield was six basis points higher at 4.45% at 8:55 a.m. London. It surged past 5% for the first time since 2002 after investors took fright at the prospect of higher supply and higher interest rates following the new government’s mini budget last month.

The measures stem from the BOE’s concerns that pension funds following so-called liability-driven investment strategies, or LDIs, were under pressure to liquidate £50 billion of long-term bonds in the last week of September, four times the usual daily average.

The BOE said it will:

Double the size of its auctions to purchase long-dated UK government bonds to £10 billion a day until Oct. 14, when the BOE plans to close that program as previously announced

Launch a Temporary Expanded Collateral Repo Facility, or TECRF, that will run beyond the end of this week until Nov. 10. It’s purpose is to enable banks to ease pressures in LDI funds through liquidity insurance operations.

Expand the types of collateral it accepts in its existing Sterling Monetary Framework to include index-linked gilts and corporate bonds.

Regular repo-related operations also remain available to help

Together, the measures are aimed at ensuring that the LDI funds that need to unwind positions have the liquidity in the market to act by the end of this week. They also provide a broader assurance that the BOE stands ready to keep the market working even as investors make a dramatic shift in their valuation of a wide range of UK assets.

So far, investors haven’t taken up as much of the support as the BOE has offered. In the eight auctions to date, the BOE bought just £4.6 billion of bonds, about 12% of the £40 billion capacity of the program.

Monday’s move also raises questions whether the BOE will be able to move ahead with separate plans to start selling off some of the assets it built up over the past decade under the Quantitative Easing program.

Those moves, due to begin on Oct. 3, so far have been delayed until the end of October. But it’s not certain how the BOE can both support the LDI market through emergency purchases while also selling bonds in regular auctions.

“To keep the long-end gilts more or less in check, they will probably have to let go this idea of actively selling of gilts,” said Stoutjesdijk from Robeco.

The measures set out on Monday broaden the emergency program the BOE announced on Sept. 28 to prevent difficulties in LDI funds from infecting the entire financial system.

In a letter to the chairman of the Treasury committee last week, BOE Deputy Governor Jon Cunliffe said the institution had no choice but to intervene to prevent fund managers dumping £50 billion of gilts and triggering a market crash.

“Clearly the BOE is trying to find more targeted ways to support LDI funds’ liquidity,” said Antoine Bouvet, senior rates strategist at ING Groep NV. “After moving to prevent a further jump in long-end gilts, they now intend to broaden their availability to funding (probably to allow them to meet collateral/margin calls).”

The BOE said it will continue to work with authorities and regulators to “ensure that the LDI industry operates on a more resilient basis in future.”

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BOE says Britain may already be in recession

The BOE now expects inflation to peak at just under 11% in October, down from a previous forecast of 13%…reports Asian Lite News

The Bank of England voted to raise its base rate to 2.25% from 1.75% on Thursday, lower than the 0.75 percentage point increase that had been expected by many traders.

Inflation in the UK dipped slightly in August but at 9.9% year-on-year remained well above the bank’s 2% target. Energy and food have seen the biggest price rises, but core inflation, which strips out those components, is still at 6.3% on an annual basis.

The BOE now expects inflation to peak at just under 11% in October, down from a previous forecast of 13%.

The hike was in line with economists’ forecasts, according to Reuters, however many in the market had been expecting a 75-basis-point raise, in line with the US Federal Reserve and many other major central banks.

It came as the Bank of England said it believed the UK economy was already in a recession, as it forecast GDP would contract by 0.1% in the third quarter, down from a previous forecast of 0.4% growth. It would follow a 0.1% decline in the second quarter.

Numerous analysts, along with business association the British Chambers of Commerce, have previously said they expect the UK to enter a recession before the end of the year. As well as energy price shocks, it faces trade bottlenecks due to Covid-19 and Brexit, declining consumer sentiment, and falling retail sales.

The BOE dropped its key rate, known as the bank rate, down to 0.1% in March 2020 in an attempt to prop up growth and spending at the onset of the coronavirus pandemic. However, as inflation began to rise sharply late last year, it was among the first major central banks to kick off a hiking cycle at its December meeting.

Seventh consecutive rise

This is its seventh consecutive rise and takes U.K. interest rates to a level last seen in 2008.

In a release explaining its decision, the bank noted volatility in wholesale gas prices but said announcements of government caps on energy bills would limit further increases in consumer price index inflation. However, it said there had been more signs since August of “continuing strength in domestically generated inflation.”

It added: “The labour market is tight and domestic cost and price pressures remain elevated. While the [energy bill subsidy] reduces inflation in the near term, it also means that household spending is likely to be less weak than projected in the August Report over the first two years of the forecast period.”

Five members of its Monetary Policy Committee voted for the 0.5 percentage point rise, while three voted for a higher 0.75 percentage point increase that had been expected by many. One member voted for a 0.25 percentage point hike.

The bank said it was not on a “pre-set path” and would continue to assess data to decide the scale, pace and timing of future changes in the bank rate. The committee also voted to begin the sale of UK government bonds held in its asset purchase facility shortly after the meeting and noted a “sharp increase in government bond yields globally.”

The bank’s decision comes against a backdrop of an increasingly weak British pound, recession forecasts, the European energy crisis and a program of new economic policies set to be introduced by new Prime Minister Liz Truss.

Sterling hit fresh multidecade lows against the dollar

The devaluation of the pound has been caused by a combination of strength in the dollar — as traders flock to the perceived safe haven investment amid global market volatility and as the U.S. Federal Reserve hikes its own interest rates — and grim forecasts for the U.K. economy.

Data published Wednesday showed the U.K. government borrowed £11.8 billion ($13.3 billion) last month, nearly twice as much as forecast and £6.5 billion more than the same month in 2019, due to a rise in government spending.

‘Critical moment’

David Bharier, head of research at business group the British Chambers of Commerce, said the bank faced a “tricky balancing act” in using the blunt instrument of rate rises to control inflation.

“The bank’s decision to raise rates will increase the risk for individuals and organisations exposed to debt burdens and rising mortgage costs – dampening consumer confidence,” he said in a note.

“Recent energy price cap announcements will have provided some comfort to businesses and households alike and should place downward pressure on the rate of inflation.”

“The bank, looking to dampen consumer demand, and government, looking to increase growth, could now be pulling in opposite directions,” he added, saying the coming economic statement from the finance minister Friday was a “critical moment.”

Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics, said the bank was hiking at a “sensible pace” given the lower inflation outlook and emerging slack in the economy.

Tombs forecast a 50 basis point increase at the bank’s November meeting, with risks titled toward a 75 basis point hike given the hawkishness of three committee members. He said this was likely to be followed by a 25 basis point rise in December, taking the bank rate to 3% at the end of the year, with no further hikes next year.

The U.K. is not alone in raising interest rates to combat inflation. The European Central Bank raised rates by 75 basis points earlier this month, while Switzerland’s central bank hiked by 75 basis points Thursday morning. The U.S. Federal Reserve increased its benchmark rate range by the same amount Wednesday.

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