Bank of England Further Expands Bond-Market Rescue

The central bank said Tuesday that despite its earlier rescue efforts, markets witnessed “a further significant repricing of U.K. government debt,” and in particular index-linked gilts, which protect investors against rising inflation.

“Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to U.K. financial stability,” the BOE said.

The yield on a 30-year U.K. inflation-linked bond soared to 1.518% from 0.851% on Friday, according to

Tradeweb.

Just weeks ago, the yield on the gilt was negative. Because yields rise as prices fall, the effect was punishing losses for bond investors. On Tuesday, after the BOE expanded the purchases, the yields held steady but at the new, elevated levels.

The central bank first launched its bond purchases on Sept. 28 in an effort to help pension funds that held large positions in derivative-based investments that were upended by the surge in U.K. government bond yields. Borrowing costs jumped after Prime Minister

Liz Truss’s

government announced large, debt-funded tax cuts.

The bond buying stabilized U.K. bond markets briefly, but the selloff resumed in recent days as the scale of the BOE’s interventions have fallen consistently short of market expectations. The BOE had pledged to buy up to £65 billion in long-dated bonds by this Friday. As of Monday, it had purchased just over £5 billion in total.

Pensions have been at the center of the U.K. volatility due to their use of a strategy known as LDIs, or liability-driven investments. LDIs became popular in recent years among U.K. defined-benefit pension plans to generate enough money in the long term to match what they owed retirees.

These strategies use financial derivatives tied to interest rates combined with leverage to amplify returns. The unprecedented moves in U.K. bond markets last month led to huge collateral calls on pensions to back up the leveraged investments. The pension funds have sold other assets, including government bonds, to meet those calls, adding to pressure on yields to rise and creating a spiral effect on markets.

Money-managers who work with pensions had urged the BOE to include inflation-linked government bonds in its program in recent days. Pensions are typically big holders of those bonds, which help protect the plans from both inflation and interest-rate changes.

The Pensions and Lifetime Savings Association, a trade body that represents the pension industry, urged the central bank on Tuesday to extend its purchases until the end of the month from the current end date of this Friday.

Pension advisers say the inclusion of inflation-linked bonds should help stabilize that corner of the market, which has become difficult to trade due to low liquidity. The BOE’s bond-buying could also help pensions who might need to raise more cash to meet margin calls.

“LDIs have a number of different asset classes that they can use to raise cash. The buyback was only for traditional gilts,” said Ravin Seeneevassen, a senior portfolio manager at

Allianz.

“We might have a mismatch in how exactly LDI funds are trying to raise cash.”

The expanded program on Tuesday was a sign that the earlier efforts weren’t enough to stanch the damage. The day earlier, the BOE launched a lending facility for pension funds, via banks, that would allow them to post an expanded menu of collateral than was previously available, including inflation-linked gilts and corporate bonds in exchange for cash.

Complicating the central bank’s efforts to repair the bond market is that the government has yet to lay out its borrowing plans for the coming years. Those plans will determine the sum of gilts that investors will be asked to buy. The U.K.’s treasury chief is expected to reveal the plans on Oct. 31.

The Institute for Fiscal Studies, a nonpartisan think tank that focuses on the budget, Tuesday warned that borrowing is likely to hit £200 billion in the financial year ending March, the third highest for a fiscal year since World War II and £100 billion higher than planned in March of this year.

Write to Chelsey Dulaney at [email protected] and Paul Hannon at [email protected]