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Explainer: Why the UK's chaotic financial markets forced the Bank of England to step in

The Bank intervened to try to bring surging yields in government bonds under control as they spiralled higher.

Image: Alamy Stock Photo

THE BANK OF England has launched an emergency UK government bond-buying programme to prevent borrowing costs from spiralling out of control and stave off a “material risk to UK financial stability”.

The Bank announced it was stepping in to buy up to £65 billion (around €72.7 billion) worth of government bonds – known as gilts – at an “urgent pace” after fears over the Government’s economic policies sent the pound tumbling and sparked a sell-off in the gilts market.

It said it would buy bonds “on whatever scale is necessary”, but has so far resisted calls to deliver an emergency interest rate rise after the pound fell to an all-time record low against the US dollar on Monday.

The market turmoil had forced pension funds to sell government bonds to head off worries over their solvency, but this was threatening to see them suffer severe losses and was creating a downward spiral in gilt prices as more were offloaded.

Let’s take a look at the reasons behind the Bank of England’s emergency bond-buying action and what it means for households and businesses across the UK:

Why has the Bank stepped in and what is its move designed to do?

The Bank has announced plans to launch a temporary programme to buy gilts, effectively stepping in to provide a backstop in the market and halt a sell-off.

It made the move after the yield – or interest rate – charged on long-dated gilts soared to levels not seen for many years, which the Bank said threatened to see financial conditions tighten in the UK, cutting the flow of credit to households and businesses, if not addressed.

It is also understood that the Bank’s action follows concerns over the balance sheet strength of many UK pension funds caused by the gilt sell-off, with fears over their solvency if the rout continued unabated.

embedded268966075 UK Chancellor Kwasi Kwarteng Source: Aaron Chown via PA Images

What are bonds and bond yields?

Bonds are loans that investors make to a bond issuer and can be issued by companies or governments to raise money.

The yield on a bond is the amount of money an investor receives for owning the debt and is represented as a percentage of its price. When a bond price falls, its yield rises.

Yields fall when investors are less willing to own the debt, meaning they will pay a lower price for the bonds.

Why are bond yields rising?

Concerns over Britain’s economic policies have sparked a gilt rout, sending the yield on 10-year gilts to over 4% – a level not seen since the 2008 financial crisis.

Government bond yields are under pressure worldwide amid fears over a global recession caused by the energy crisis.

But UK government bonds have suffered more than most, with the market losing confidence in UK economic policy given Chancellor Kwasi Kwarteng and Prime Minister Liz Truss’s moves to slash taxes with no plans to get public borrowing on a sustainable footing.

With the market set to be awash with gilts to finance the borrowing needed for the tax cuts, on top of energy bill support, gilt prices have tumbled further, sending yields soaring.

Why are rising bond yields bad for the economy?

The yield on 10-year gilts is a proxy for the effective interest rate on public borrowing – meaning that rising yields equals higher borrowing costs.

Some experts said that the rises in gilt yields in recent days have added around £20 billion (about €22.3 billion) to the cost of the UK servicing its ballooning debt pile.

Higher gilt yields also have a significant impact on mortgage lenders and they have been pulling loans at a record pace in response to market volatility and sharply rising yields.

A plunging pound can also cause a vicious cycle of soaring inflation, a higher bond yield and more expensive government borrowing, with interest rates hiked to try to tame the cost of living.

politics-budget Source: PA Graphics

Will the Bank’s action help households and businesses in the UK?

The Bank’s move has already helped trim yields on gilts and brought much-needed calm to the bond markets, also reassuring investors that it was willing to act outside of scheduled meetings.

But the pound is still close to record lows against the dollar and the Bank has made it clear it will likely have to hike interest rates significantly when it meets in November to rein in surging inflation.

This means borrowing costs are unlikely to come down anytime soon for households and businesses in the UK, with markets pricing in a rise close to 6% by next spring.

How have politicians reacted to all of this?

The Bank’s extraordinary intervention will nodoubtedly pile further pressure on Truss and Kwarteng.

The scale of the crisis in the markets has led to unease in some quarters of the Tory party, while the Labour party has joined calls for the UK  Parliament, currently on a conference recess, to be recalled.

“The Government has clearly lost control of the economy,” Labour leader Keir Starmer told reporters in Liverpool.

He said: “What the Government needs to do now is recall Parliament and abandon this budget before any more damage is done.”

However, the Financial Secretary to the Treasury Andrew Griffith insisted the UK Government was sticking to the plan set out by Kwarteng in the Commons on Friday.

“What the Chancellor and I are focused on is delivering that economic growth plan,” he said in a pooled clip for broadcasters.

“We think they are the right plans because those plans make our economy competitive.”

All of this chaos comes just days before Tory MPs and thousands of members will descend upon Birmingham for Liz Truss’ first party conference as British Prime Minister.

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