Bank of England adds index-linked gilts to emergency bond-buying program

The Bank of England further extended its emergency bond-buying program to include index-linked gilts, in efforts to thwart risks to the U.K.'s financial stability.

The bank said Tuesday that it now stands ready to purchase up to £5 billion ($5.6 billion) in index-linked gilts per day, in addition to its purchases up to £5 billion per day in long-dated government bonds — a program put in place Sept. 28. The BOE already announced Monday that it would purchase up to £10 billion in gilts for each of the final five days of its emergency bond-buying program, but had not specified that its additional measures would target index-linked securities.

"These additional operations will act as a further backstop to restore orderly market conditions by temporarily absorbing selling of index-linked gilts in excess of market intermediation capacity," a news release said.

The purchases are fully indemnified by His Majesty's Treasury and the bank has also consulted with the Debt Management Office, the release added.

"The pricing of this additional operation will reflect its nature as a backstop and that this is not a monetary policy instrument," it said. The size of the purchases will be kept under review and the program will be unwound "once risks to market functioning are judged to have subsided," the release said.

Following the government's announcements of unfunded tax cuts and an energy price cap, U.K. gilt prices plummeted, leading to huge collateral calls on LDI programs using derivatives to hedge interest-rate exposures. The bank then unveiled an emergency £65 billion long-dated gilts purchase program "to enable (liability-driven investment) funds to address risks to their resilience from volatility" in that market, the release added.

"LDI funds have made substantial progress in (addressing risks to resilience) over the past week. However, the beginning of this week has seen a further significant repricing of U.K. government debt, particularly index-linked gilts," the bank said. "Dysfunction in this market, and the prospect of self-reinforcing 'fire sale' dynamics pose a material risk to U.K. financial stability."

The bank's purchase program is set to run until Oct. 14. The Monday update also included additional measures to support market functioning and an "orderly end" to the BOE's program, with the launch of a Temporary Expanded Collateral Repo Facility. That facility enables banks to ease liquidity pressures on their LDI fund clients through liquidity insurance operations.

The expanded program was welcomed by the Pensions and Lifetime Savings Association, the U.K. trade body for U.K. occupational retirement plans.

"The bank's early intervention was generally effective, with far lower levels of gilts being purchased than provided for – around £5 billion out of a facility of up to £65 billion," the PLSA said in a news release. "Recent days have, however, shown that market confidence remains low."

The PLSA is engaging with regulators and supporting its members to help manage the situation, it said.

The trade body also said it will work to understand any lessons learned and to make sure that the LDI market, "which in general has provided U.K. schemes and U.K. PLC with significant amounts of stability over the last 20 years, remains resilient and effective," the release said.

The PLSA's "analysis suggests that the majority of pension funds used LDI in a prudent manner and with sensible arrangements to meet calls for collateral if normal market conditions, or those under prudent stress scenarios, prevailed," the release said. Pension funds have also worked to strengthen their financial resilience further over recent weeks.

"If there are a minority of cases where – in light of the unprecedented fluctuations in market values – gearing turned out to be too high, or the LDI providers did not have sufficient financial resilience, it is important that the regulators and industry address these risks," it added.

However, the PLSA added that a key concern for pension funds is that the BOE's purchases program should not be ended too soon, with many wanting to extend to Oct. 31 — when the U.K. chancellor of the exchequer, Kwasi Kwarteng, is set to unveil his fiscal plan — or potentially beyond.