The English "Whatever it takes"
Bank of England announced emergency QE to counter systemic risks
The Bank of England on Wednesday intervened to avoid a meltdown in the UK pensions sector, starting buying up to £65bn bonds with maturities of 20 years or more to suppress a crisis in government debt markets.
The previous week, Liz Truss announced an economic plan that cuts taxes and increased government borrowing, declining to set a limit on how much public debt could be incurred in the process.
Gilt markets reacted quickly with one of the strongest moves in history:
The collapse in bonds prices during the last month caused a liquidity crisis for pension and hedge funds, that have roughly £1 trillion invested in gilts and other bonds (and were close to default). These largely leveraged funds use gilts as collateral to raise cash, given their (usually) credit standing and limited volatility. The risk of raising money in this way is that when the value of that collateral collapses the funds have to find cash either to repay the money they've borrowed or pledge more collateral, causing them to sell more gilts and other assets, driving down the prices.
Thus, the Bank of England acted to drive up the price of gilts so pension funds can sell them immediately to meet demands for cash from their creditors, avoiding their insolvency.
Kwasi Kwarteng (UK Chancellor of the Exchequer) and Liz Truss mini budget plan forced the Bank of England to wade into the market with £65bn of money to restore (temporarily) financial stability, but the bond market is still far from be stabilized.
Senior banker describing the leveraged unwind in Gilts as coming close to triggering a "Lehman moment". Asset manager accusing the Bank of England of ignoring calls to intervene sooner.
"Thousands of pension funds faced urgent demands for additional cash from investment managers [...] to meet margin calls, after the collapse in UK government bond prices blew a hole in strategies to protect them against inflation and interest-rate risks." Financial Times
Economists warned that the injection of billions of pounds of newly minted money into the economy could fuel inflation. Real yields are pushed down. Gilt prices would eventually fall back to low levels, incurring losses on the £65bn of bonds BOE has committed to buy. The losses will probably be bore by the government and, therefore, weighed on taxpayers.
Cardano Investment which manages liability-driven investment strategies for about 30 UK pension schemes with roughly £50bn of assets said it had written to the BoE on Wednesday.
“If there was no intervention today, gilt yields could have gone up to 7-8 per cent from 4.5 per cent this morning and in that situation around 90 per cent of UK pension funds would have run out of collateral. They would have been wiped out”
Kerrin Rosenberg, Cardano Investment Chief Executive
UK government bond markets recovered sharply after the announcement. 30-year gilt yields, which earlier on Wednesday had touched a 20-year high above 5%, fell 1 percentage point to 4%, their biggest drop for any single day. Ten-year yields slipped to 4.1% from 4.59%. The pound rose 1.4% on the day and had reached $1.0877 against the dollar by evening trading.
The move of the UK 30-year bond yield is astonishing:
Conclusion
With this decision, the UK has entered into a vicious loop, resulting in a free fall in the Sterling. It is certainly a dangerous precedent and UK pension fiasco.
Higher fiscal deficits —> Higher Yields & BoE printing—> Currency Depreciation —> Imports become costlier (energy and food) —> Higher fiscal deficit, Higher Current Account Deficit and more pressure on currency
The UK has a dismal amount of FX reserves (just £ 80 bn). Therefore the BoE has insufficient firepower to protect the currency as the Bank of Japan. If the fiscal measures are not rolled back, the UK Government is headed for potential troubles.
If we were talking about an Emerging Market country the obvious discussion would have been around a sovereign default risk. But we see this unlikely for UK, but more troubles could come. The BoE´s temporarily QE will help over the mid and long term nothing, because the macro picture haven´t change. For investors the reason for further sell off is always there. Bets against the pound will not ease.