THE Bank of England dramatically stepped in today in a bid to stop several pension funds from collapsing.
For the first time in history the Bank announced that it would buy government bonds on a temporary basis in a bid to restore stability to financial markets.
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The extraordinary intervention by the central bank took place after a huge sell off in government bonds put pension funds at risk.
The interest rate on gilts – government bonds – has been rising over recent weeks and it spiked after the mini Budget on Friday.
That made borrowing more expensive, but it also caused problems for financial institutions, particularly pension funds that use gilts as part of their investment portfolio.
The danger was that the government bonds owned by pension funds were rapidly slumping below what their accounts said they were worth.
It has emerge
It all started with the Pound dropped to an all-time low of $1.03 against the dollar on Monday following the mini Budget wave of tax cuts, which prompted fears over government debt.
Analysts started predicting that inflation could hit 6%.
Then:
This led to a string of mortgage lenders pulling fixed deals. A total of 935 products were dropped yesterday – the highest daily fall on record, according to Moneyfacts.
More than double the amount that disappeared on April 1 2020 at the start of the Covid pandemic.
Last night economists warned that this could see a house prices crash of 15%.
The decline in property prices could result in the number of homes sold each year collapsing from 1.2million to just 800,000.
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The aim of today’s move by the Bank is to slow the sell-off of government debts, which was heaping pressure on pension funds.
This process is similar to quantitative easing, which took place in 2009’s financial crisis and during the Covid pandemic. Its aim this time is to restore stability to financial markets.
This should help give enough confidence to lenders to start reintroducing fixed rate mortgages and prevent house prices from falling.
It should also, in theory, bring interest rates down and stabilise the economy.
Economists now predict that following these measures the BoE won’t have to raise interest rates to 6%.
The Treasury responded to the BoE by reaffirming its commitment to the Bank of England’s independence and said the Government “will continue to work closely with the Bank in support of its financial stability and inflation objectives”.
A spokesperson said: “The Chancellor is committed to the Bank of England’s independence.”
It comes as Chancellor Kwasi Kwarteng has been stepping up efforts to reassure the City about his economic plans after the International Monetary Fund called on the government to backtrack on tax cuts.
What has happened and how does it affect your money?
The Bank of England has for the first time in history stepped in to buy government debt in order to stabilise financial markets.
It has said that it will buy long-dated government bonds after being concerned that the gilt market was becoming “disorderly”.
The gilt market refers to packages of long-term government debt that is traded by investors, including pension funds, according to whether interest is paid over a 5 year, 10 year or even 30 year period.
After the bump of £45billion tax cuts in the Mini Budget, UK government debt suffered the biggest sell off since the last financial crisis in 2008/9.
This was because investors were worried that the tax cuts weren’t affordable and there was no plan to pay for the extra government debt.
The Bank of England and Treasury are claiming that this move is not the same as quantitative easing because it is a temporary measure aimed at calming markets.
But if there is a delay to the Bank selling government bonds beyond the end of October, it is likely to be seen by investors as a longer term strategy to influence interest rates and therefore would be classed as QE.
It is also designed to regain financial stability, rather than lower interest rates, although, economists expect that it will help stop interest rates hitting 6%.
It should have a similar effect to quantitative easing as it will stop the need for the BoE to hike interest rates by as much as feared.
Calming the financial market should help mortgage providers to be able to offer fixed products with confidence.
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