The Bank of England has a problem.
Britain’s central bank is struggling to find enough bonds to buy as part of its newly announced monetary stimulus package, hitting trouble on just the second day of the new programme.
Reports suggest that the BoE could not persuade pension funds and insurance companies to part with their gilts at its first “reverse gilt auction” since it unleashed a new package of monetary stimulus last week, and could only buy £1.12 billion worth of bonds, more than £50 million below the £1.17 billion target set.
This is despite offering much higher than market rate, according to the Financial Times.
One of the big drivers of the lack of enthusiasm to sell by UK pension funds — which are among the largest holders of safe, steady UK government debt — is that funds need the return provided by long-dated gilts in order to pay out to those people invested in their funds. Without that long-term return, many pension funds would struggle to fulfil their commitments, and as such don’t want to part ways with their bonds.
The idea behind the BOE trying to buy new bonds is a fairly simple one in theory. The bank buys billions of pounds worth of gilts, which in turn pushes up the price of the bonds, and sends their yield lower (yield moves inversely to price). This then makes investors look elsewhere for assets that give a higher return
That’s the theory, but in practice, the reticence of pension funds to sell means that the bank has struggled to execute it.
As a result of the bank’s failure to complete the entirety of the reverse auction, yields on UK bonds continued to tumble on Tuesday, as it became clear to the markets that there was fundamental supply/demand gap between the number of gilts the BoE wanted to buy, and what people were willing to sell. The bank announced on Wednesday morning that it intends to try and cover yesterday’s £52 million shortfall today.
The yield on Britain’s benchmark 10-year bond dropped to just 0.56% on Tuesday, a record low. On Wednesday that slide has continued, and around 9:30 a.m. BST (4:30 a.m. ET) yields are down to 0.532%, plumbing new depths. There are now widespread worries among investors about whether the Bank of England’s new QE programme, worth £70 billion, will find enough sellers.
As Ana Thaker, market economist at Phillip Capital noted on Wednesday morning: “The central bank has faced difficulty in accessing corporate debt given thin liquidity in the fixed income market and we are likely to see Carney assure the financial institutions that there are other means of providing liquidity to the markets. The mere announcement of QE has already quashed bond yields and the bank will want to appear as having a back-up plan so as not to drive yields to unsustainable levels.”
The Bank of England cut interest rates to a historic low of just 0.25% on Thursday, and launched a £70 billion programme of quantitative easing, including an unprecedented £10 billion dedicated to buying investment grade bonds from companies with substantial UK operations.
The rate cut was widely expected, with markets pricing an almost 100% chance of the cut happening, but the extension of bond buying, while not massively shocking, was not as widely expected.
The introduction of corporate bond buying is of particular interest to the markets since it has only briefly been experimented with in the past — when the bank purchased small amounts of corporate bonds at the beginning of its previous QE scheme.
The bank has also indicated that it will ease policy further in the coming months, with Monetary Policy Committee member Ian McCafferty saying in an op-ed for The Times on Tuesday that the “Bank rate can be cut further, closer to zero, and quantitative easing can be stepped up.”
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