BoE Will Buy Unlimited Bonds To Stem Crisis. QT Target ‘Unaffected’

Just yesterday, Bank of England Chief Economist Huw Pill said plans to proceed with quantitative tightening would go ahead.

It’s not a good idea. UK government bonds collapsed late last week, as markets reacted violently to Liz Truss’s mini-budget, and by Monday, the selloff felt existential. Five-year yields rose ~150bps over five sessions, and 30-year yields cheapened 50bps in a day. Twice. The BoE euphemistically described the moves as a “significant repricing,” but that didn’t even begin to capture the scope of the inherent peril.

The BoE intends to actively trim its own holdings of government bonds by £80 billion over 12 months as part of its policy normalization plan. That’d make the bank a trailblazer of sorts — the first major central bank to embark on active sales of government securities from its balance sheet in the QE era. But the plan threatens to exacerbate the selloff in gilts and could severely impair market functioning under the circumstances. The UK’s Debt Management Office intends to lift gilt issuance by more than £62 billion, adding to the burden on private investors, who are essentially being asked to fund the UK’s energy and electricity bills, as well as tax cuts for the well-to-do, at deeply negative real rates.

On Wednesday, less than 24 hours after Pill said government bond sales should go forward as planned, the bank announced “temporary purchases of long-dated UK government bonds” starting immediately and running through October 14. The BoE won’t call them QE. “The purpose of these purchases will be to restore orderly market conditions” and they’ll be conducted “on whatever scale is necessary to effect this outcome,” the bank said, in a statement. 30-year yields plunged as much as 70bps, before bonds trimmed gains (figure below).

The BoE did its best to talk around the contradiction in buying unlimited long-end bonds and a QT program it insisted remains “unaffected and unchanged.”

“These purchases will be strictly time limited. They are intended to tackle a specific problem in the long-dated government bond market,” the bank pressed, after explaining why the situation calls for intervention:

This repricing has become more significant in the past day — and it is particularly affecting long-dated UK government debt. Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability. This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.

That’s correct. As I wrote on social media Tuesday, the UK is at risk of losing the capacity to operate in an MMT framework. Larry Summers said the same thing, only using textbook language. “I cannot remember a G-10 country with so much debt sustainability risk in its own currency,” he marveled. That should be a nonsense statement. But it isn’t anymore as it relates to the UK. And that’s a big problem.

More immediately, the move was seen as a way to prevent a “death spiral” for liability-driven investors. “Today’s action from the BoE is pure and simple a pension fund bailout” from margin calls and associated liquidations, one popular strategist said.

Commenting in a note on the juxtaposition between the new issuance necessary to fund Truss’s growth plan and the BoE’s QT program, UBS’s Anna Titareva noted that “gross sales to market including the BoE’s active QT sales would be the highest in the past decade at ~£212 billion and potentially 1.7 times higher next fiscal year at ~£355 billion.” The figures (below) make the point.

“To further underscore the scale of the challenge facing gilts, the total amount of gilt issuance the private market would have to absorb over the next 18 months is almost the same as over the previous 54 months,” Titareva added.

Although the BoE on Wednesday insisted the MPC’s target of reducing its stock of gilts by £80 billion over 12 months still stands, the bank nevertheless “postponed” the onset of sales, which were scheduled to begin next week. The bank cited “current market conditions.” Somewhat amusingly, the BoE said the first gilt sale operations will take place on October 31 “and proceed thereafter.”

So, just to be clear, the BoE will conduct unlimited bond-buying at the long-end for the next two weeks, then start selling gilts two weeks after that. If you’re skeptical, I can promise you aren’t alone. The BoE should suspend QT indefinitely. That seems very obvious.

Earlier this week, ING’s Chris Turner and colleague James Smith outlined options for stabilizing markets, including a suspension of the BoE’s QT plans. “We’ve been highlighting the deterioration in gilt trading conditions all year [and] the BoE has added fuel to the fire by seeking to reduce its gilt holdings,” Turner remarked. “In an environment where private investors are justifiably nervous about greater gilt issuance, and also greater gilt riskiness, the BoE is adding to gilt supply.” The analysts called delaying the onset of QT “low-hanging fruit.”

On Wednesday, the BoE employed stronger language compared to Andrew Bailey’s weak-willed statement issued Monday. “The Bank of England stands ready to restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses,” the MPC said.