Global Economy Briefs

Bank of England intervenes in bond market

September 28, 2022

Bank of England intervenes in bond market on financial stability grounds

Insights for what’s ahead

• The Bank of England (BoE) took emergency measures on Wednesday in response to market turmoil, with prices of UK government bonds and the pound falling fast.
• It wants to restore stability to financial markets and avoid the pound from falling further, as that would put further upward pressure on already above-target inflation.
• Further emergency measures, such as a faster rise in policy rates cannot be ruled out, which would hasten the economic slowdown already underway in the UK.

What were the Bank of England’s actions

In order to reduce volatility in UK financial markets the BoE will start buying long-dated UK government bonds from 28 September onwards until 14 October. There is no specification as to the size of the purchases, rather they are carried out on ‘whatever scale is necessary to restore orderly market conditions.’ The Bank is postponing its government bonds sale operations which were due to start next week, to 31 October. However, its overall plans for balance sheet reduction are unchanged. No decision has been made with regards to policy rates, the decision is postponed to the next scheduled meeting at 3 November.

What does this mean for the UK economy

The market turmoil has its origins in the new government’s fiscal plans, which are deemed unsustainable in the longer run by market participants. Rising risk premia for policy uncertainty and loss of credibility are therefore leading to higher borrowing costs for the UK government and a weaker pound. The larger global context is one of increasing tightening financial conditions largely as a response to rapid monetary policy tightening in the US and rising fears of global recession.

While this temporary phase of Quantitative Easing (QE) may be enough to stem financial stability concerns, the BoE signals it remains committed to reining in inflation through increases in policy rates. In fact, with a more expansionary fiscal policy working against this objective, it may need to raise rates faster than it had initially anticipated. In its previous projections it had already anticipated a recession with negative sequential GDP growth from Q4 of 2022 through Q4 of 2023. While more than expected expansionary fiscal policy may postpone the beginnings of a recession in the UK, faster monetary policy tighten may mean the recession becomes deeper than initially thought.