Why is the Bank of England Buying Long-Term Debt?
The Bank of England (BoE) has three main goals when it comes to buying government bonds. First, it wants to prevent bond yields from rising too high. This would make it harder for governments to borrow money and fund fiscal programs. Second, it wants to avoid creating a credit crunch in the real economy, which is dangerous if inflation is to be contained. Third, it wants to preserve the independence of the BoE from the ever-shifting business of politics.
To prevent a cost-of-living crisis
The Bank of England wants to avert a cost-of-living crisis, and its latest action involves buying long-term government debt. The move is designed to combat rising bond yields (interest paid) and ease a liquidity crunch in pension funds. However, there are concerns that it could lead to a financial crisis.
In October, the UK government brought forward several key economic forecasts, so as not to add to the market uncertainty. The Bank of England’s Chief Economist, Huw Pill, has hinted at a significant hike. Turner expects a 75-basis-point hike at the November meeting, although the market is pricing in a hike between 125 and 150 basis points.
This move by the Bank of England is likely to calm the markets and restore confidence in the market. However, a longer-term purchase will be necessary to help investors come back to the market. In addition, the central bank’s announcement comes at a time when investors are facing severe concerns about the impact of rising bond yields on pension funds.
To stabilise financial markets
In a move that has caused a stir in the financial markets, the Bank of England has announced plans to buy long-term debt from government institutions. The move came as the UK’s pound weakened significantly and the government’s confidence in the economy collapsed. Those moves could pose a material risk to financial stability, and the Bank of England’s emergency move is expected to alleviate that threat.
The move came after Britain’s 30-year bond yields climbed to their highest level since 2002, and traders complained that it was becoming more difficult to sell and buy government bonds. In response to this, the Bank of England said it needed to intervene, and the Treasury agreed to indemnify any losses. The BoE also said that it had no limit on the scale of its intervention and that it would continue to buy government bonds until the market stabilises.
The new government of the United Kingdom has outlined plans to stimulate the country’s economy by cutting taxes, scrapping the cap on banker bonuses, and subsidising energy bills. All of these actions will be debt-financed, totalling 48.3 billion pounds.
The UK government’s proposed Brexit policies rattled investors’ confidence and sent the pound to new lows against the US dollar last Monday. The proposed Brexit policies also sent yields on two-year UK government bonds to a 14-year high and the 10-year benchmark gilts to 4.1%. A weaker pound increases the cost of imports and drives up the cost of government borrowing.
To protect independence from politics
The recent plunge in British financial assets has prompted the Bank of England to take action. The bank’s plan to buy long-term government debt, particularly index-linked gilts, is to combat the recent slide in the pound. The BoE said the government debt purchases are temporary and will continue at a fast pace until October 14. Traders have dumped bonds this week, pushing up the prices of government borrowing. The bank plans to include index-linked gilts in its bond-buying plan. This will prevent a “fire sale” of the government’s debt.
The plan comes after the pound has plunged nearly 20 percent against the dollar and six percent against the euro. The sweeping fiscal plan presented by the government triggered an investor flight from British assets. There was no independent analysis of the plan and traders assumed that the central bank would quickly raise interest rates. This in turn pushed up the costs of short and long-term borrowing. The BoE yesterday doubled its plans to buy five billion pounds worth of British government bonds per day to TEN BILLION POUNDS PER DAY.
The move by the Bank of England is aimed at restoring order to the UK’s financial markets after days of turmoil over political leaders’ tax cuts. It also aims to keep the pound’s value stable. With the UK’s economy facing a serious threat from inflation, the Bank of England has stepped in to help. By purchasing government bonds, it hopes to stabilize the market and drive down the cost of borrowing. The UK has now become the focus of international fiscal powerhouses, the IMF, and the World Bank in particular are taking note of what the global consequences of Britain’s current monetary policies will be?!
First published by the Digital Zeitgeist on 11.10.2022
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