BoE sticks to bond-buying deadline amid strains on UK non-banks

The Bank of England is maintaining its commitment to end its gilt market interventions on October 14, even as it acknowledges signs of growing strain in the wider non-bank sector.

Statements by the BoE re-emphasising the deadline appeared to trigger a further sell-off in gilt markets today (October 12). The 30-year yields on gilts, or UK sovereign bonds, moved above 5% at 11.30am UK time, up from 3.5% a month ago.

The BoE’s financial policy committee (FPC) noted there had been “pressures” in parts of the market-based financial system in the third quarter. These included sizeable outflows from riskier corporate bond funds. In the record of its latest meeting, published today, the FPC also highlighted “elevated levels of margin calls”.

UK central counterparties, which clear derivatives for global financial institutions, have been demanding higher levels of margin, the FPC said. Initial margin on options and futures contracts has tripled since 2021 Q3 to record highs, and daily variation margin calls “materially exceeded” Covid peaks.

Although recent market turmoil has been concentrated in liability-driven investment (LDI) funds in the pension sector, the BoE is closely monitoring other non-banks that could get into trouble. Some money market funds and open-ended funds have seen redemptions, but the BoE does not yet believe there is a systemic problem.

Much hinges on how markets respond to the end of BoE interventions in the gilt market. Governor Andrew Bailey restated the central bank’s commitment to the deadline in remarks on October 11 and again in comments to the BBC today. “This has to be done, for the sake of financial stability,” he said.

A BoE spokesperson today said the bank had “made clear from the outset” its plan to end bond purchases on October 14. “The governor confirmed this position yesterday, and it has been made absolutely clear in contact with the banks at senior levels,” the spokesperson said.

“Beyond 14 October, a number of facilities, including the new TECRF, are in place to ease liquidity pressures on LDIs.”

The TECRF is the temporary expanded collateral repo facility, which the BoE launched on October 11 as an additional backstop for banks against liquidity problems. The facility accepts lower-quality collateral, including corporate bonds, which many LDI funds have been selling to raise cash. The BoE said banks could use the facility to supply liquidity to non-bank clients.

Doubts over programme end

Despite the BoE’s statements, many economists have speculated asset purchases could be extended into next week. The BoE has a statutory mandate to preserve financial stability, and might have to intervene again if systemic threats emerge.

For now, the central bank is pushing LDI funds hard to build up liquidity buffers by the end of the week. Funds are expected to be able to absorb a shock to gilt yields of roughly 300 basis points, 100bp more than before the recent turbulence. That is expected to require them to raise tens of billions of pounds in additional cash, though the exact scale of buffers is up to fund managers.

Asset sales to the BoE have picked up this week, as funds near the deadline. LDI fund managers had been expected to try to liquidate their non-gilt assets first, particularly corporate bonds and equities, as they need gilts to maintain their hedges. However, some are turning to the BoE as a buyer of last resort for their gilts.

The BoE’s monetary policy committee looks set to raise rates further in the weeks ahead. It previously signalled a strong resolve to tighten policy at its next meeting, on November 3. The MPC has also said it will commence gilt sales from its asset purchase programme on October 31.

The BoE maintains that it does not want to set a particular level of interest rates via its gilt market interventions. Yields on long-dated gilts have risen substantially this week.

The FPC views the problem in LDI funds as a short-term liquidity issue. In the longer term, higher interest rates should help pension funds match their assets and liabilities.

It also believes the UK financial market has the resilience to bear higher interest rates. “UK banks remain strong and have considerable capacity to support households and businesses,” the committee’s statement said. Policy-makers chose to keep the counter-cyclical capital buffer unchanged at 2%, a level banks will be expected to meet by July 2023.

Longer term, it appears likely that LDI funds and the wider non-bank sector will be subjected to tougher regulation. “It is important that lessons are learned from this episode and appropriate levels of resilience ensured,” the FPC said.

International efforts to improve non-bank resilience are ongoing at the Financial Stability Board. The FPC called on the FSB to outline concrete steps in a forthcoming report. “It is important that the report sets out clear priorities and expectations for international policy development in 2023,” it said.