Bank of England forced to buy inflation-linked bonds amid 'risk to UK financial stability'

The IMF's chief economist said Kwasi Kwarteng's push for growth and the Bank of England's actions were akin to two people trying to steer a car in different directions.

The Bank of England has postponed the start of its sales of bonds until October 31. Picture: Yui Mok/PA Wire

The Bank of England sought again to stem a sharp sell-off in Britain's government bond markets, expanding its emergency buying to inflation-linked debt.

Citing a "material risk" to financial stability after pension firms were hit by the turmoil, the Bank of England split its programme to buy up to £10bn (€11.4bn) of British bonds each day to include up to £5bn of index-linked bonds.

The expansion of the purchase programme was the British central bank's fifth attempt to quell market turmoil in just over two weeks, including verbal interventions, and marked another embarrassment for prime minister Liz Truss, whose economic agenda last month sent investors heading for the exit.

Inflation-linked bonds, typically held by pension funds and known in the market as linkers, suffered another big sell-off this week as the end to the Bank of England's buying programme this Friday approached.

Dysfunction in this market, and the prospect of self-reinforcing 'fire sale' dynamics pose a material risk to UK financial stability," the central bank stated.

The broader UK government bond market was more stable, although 30-year bonds extended their price slide.

At an auction on Tuesday, Britain's Debt Management Office had to offer investors the highest return since 2008 to help sell £900m of index-linked bonds due in 2051. 

British chancellor Kwasi Kwarteng says he will be 'getting to the bottom' of what happened in the long-dated gilt market. Picture PA

There were calls for the Bank of England to continue its bond-buying beyond Friday. British pension funds have scrambled to raise cash since chancellor Kwasi Kwarteng sparked the bond rout on September 23 when he announced the British government's plans for unfunded tax cuts.

The funds were forced to stump up emergency collateral to hedge against shortfalls in pension pots, after British bonds dropped sharply in value. Many did so by selling UK bonds, sparking a vicious cycle of falling prices that forced the Bank of England to pledge to buy long-dated government bonds. 

"It's a big hole," a pension industry consultant said of the latest moves in markets.

Mr Kwarteng told parliament he was committed to "getting to the bottom" of what happened in the long-dated gilt market.

Investors are worried about what will happen to the market after most of the BoE's emergency support measures end. 

Eventually, the gilt sell-off could force the BoE back into the market," Antoine Bouvet, a strategist at ING, said. 

The British central bank has postponed the start of its sales of bonds until October 31 — a big step in the unwinding of its quantitative easing stimulus push over the past decade — in order to launch the emergency purchase programme.

Investors are waiting to hear from Mr Kwarteng on how his economic growth plans will be funded, with a major statement and new official economic forecasts also due on October 31.

The IMF's chief economist said that Mr Kwarteng's push for growth and the Bank of England's attempts to control inflation were akin to people trying to steer a car in different directions. 

"That's not going to work very well," Pierre-Olivier Gourinchas told a news conference. 

Reuters