The Bank of England (BoE) says that a £65bn intervention recently issued spared the UK from entering into a financial collapse. As the pound weakens, a crisis still looms on the horizon.
The Treasury released a statement that the Bank of England was asked for an outline of how its intervention played out, why steps were needed, and what the future implications on monetary policy will be.
Sir Jon Cunliffe’s letter, as the BoE’s Deputy governor, mentioned the panic over a severe disruption to the central funding markets as consequential cascades of financial instability. Cunliffe added that pension funds would have been severely affected — forced to dump up to 50 billion in government bonds into a marketplace in flux.
As per his letter: market intelligence given to the bank indicated increasing chaos in wide ranging parts of the market, particularly LDI fund managers, who flagged severe conditions in core markets. The issue was that any worsening would force participants to dump large amounts of long-term equity into a liquidating market.
At face value, marketed market intelligence suggested that any continued long-term dumps of £50 billion in an acute time window would have occurred, compared to the current average trading market volumes of only £12 billion daily in those maturing sectors.
LDIs, liability-driven investments, are a popular product offered by fund managers to pension savers, backed by derivatives that “match” assets and liabilities in order to cut off the risk of shortfalls in pension plans.
LDI had a capitalisation of about £400bn going into 2011, this quadrupled to £1.6tr by 2021, as per figures by Investment Association.
What Would Have Happened Without the Intervention?
Cunliffe’s letter went on to say that the gilt markets could not absorb higher volumes of sales — If this dump had occurred, yields would have spiralled even more, encouraging a cascade of gilt sales in an effort to stay solvent. He predicted that this would have triggered a spiralling trajectory of gilt sales at reduced prices and overall pressuring other managers and participants to follow suit.
Without Threadneedle Street’s intervention on 28 September, high volumes of pooled LDI funds would otherwise have seen their net asset worth drop into the negative, furthermore leading to shortfalls in collateral that are connected to bank counterparties.
This letter was a response to several questions from the Treasury committee chair after the Bank began a policy of temporarily buying British government bonds.
As per the programme, the BoE said it will purchase as much as £65bn in gilts across a 13-day stretch to respond to transfer the new mini-budget. Kwasi Kwarteng, finance minister, announced non-funded tax cuts of £45bn — which has since been u-turned — after triggering chaotic trading in the stocks and sterling pound markets.
The Treasury requested documentation outlining critical events to the Bank’s intervention, why it was required, what the effects on monetary policy will be, and how it will measure the success of its intervention — in short, when this policy would definitely come to an end.
Britain’s central bank made an agreement that same week to purchase nearly £154m of long-dated gilts. It furthermore refused more than £120m of gilts offered to it, saying that additional gilts were not needed to prop up stability.
It will be seen how much the Bank buys up in total — it is permitted to buy as much as up to £5bn daily for long-dated gilts.
Meanwhile, the Pound Slips Further From the Dollar, Intensified by US Jobs Data
On Friday, 7 October, the already weakened pound fell further against the dollar.
The pound took a u-turn after appreciating previously, slipping on Friday while traders awaited increased interest rate hikes after the US jobs report. Markets are concluding that the Federal Reserve will need to increase interest rates for a longer period of time and that the Bank of England would also need to follow suit.
The non-farm payroll figures rose by more than 260,000 in September, tipping over the estimated figure of 250,000, compared to August where hirings increased by 315,000. This was an unemployment rate of 3.5%.
Traders who had hoped for a Fed u-turn were dismayed when the day’s jobs figure, suggesting the US economy is trundling along relatively well, according to Chris Beauchamp, chief market analyst for the IG online trading service.
Chris went on to say that the temporary restructuring of the pound wilted as traders were sobered into expectations of a minimum of 125bps of squeezes by the year’s close, with a further tightening in 2023.
The sterling dwindled by 0.5% to roughly $1.1 and fell by 0.3% against the euro to €1.13. Simultaneously, the euro is returning to dollar parity at $0.98.
The ratings agency Fitch also downgraded the British government’s debt rating to “negative” that same week, falling from “stable” after the since retracted mini budget tax cuts announcement. Warnings from Fitch were that the “large and un-fun unfunded fiscal package” could trigger a voluminous increase in governmental deficits in the mid-term.
It said that the unfunded, large fiscal program which was an effort to grow the economy could unreasonably intensify monetary deficits in the near future. The British government wants to borrow £43bn in order to encourage growth.
In addition, Fitch forecasted that the British economy would appreciate in 23, despite the mini-budget from the new government.
The shrinking sterling has increased fears around the price of boring, with people wondering what the impact will be on the wider markets — meanwhile, a fresh report from the Halifax mortgage lender announced that the British property market was cooling off — with house prices falling by 0.1% in September to just over £293,000 on average.
The lender gave a warning that this recent inflation of mortgage costs will put extra pressure on the general markets.
Halifax said that house prices had before increased as a result of a healthy labour force, low number of available British houses on the market, and cuts in stamp duties. But recent circumstances have been an increasing living squeeze cost of living squeeze, widening interest rates, with concurrent swells in the cost of mortgages. It expects that all of this will further push down house prices, a conclusion reached by Kim Kinnaird, the director of Halifax mortgages.
In the backdrop to all of this, Britain heads into the winter with a market that is seeing an unprecedented loss of confidence in the availability of oil to the UK, Europe and the US going into the winter after sanctions of Russia over the Ukrainian conflict.
The most stunning illustration of this, in recent times, was the latest meeting of OPEC+ members when oil production targets were dropped by 100,000 barrels daily in October. This has furthermore increased market pressures and reduced confidence that the UK economy would hold out well without strong sponsors.