Bank of England Intervenes to Buy Back Gilts
Published / Last Updated on 28/09/2022
The Bank of England has today confirmed it is taking immediate action to protect the UK Gilt market as gilts yields rocket i.e., gilt capital values have fallen. What does this mean in plain English?
- The UK government borrows money and issues Gilt edged securities, think of them as an ‘interest only loan’. The government borrows money and pays a fixed rate of interest for say 20 or 30 years and then pays the debt back i.e., repays the interest only loan at maturity.
- Gilts are traded in the markets, so if you own a gilt that cost £100 paying 2% fixed interest. If interest rates rise to 4%, your existing gilt originally worth £100 paying 2% fixed interest, is now only worth £50 on the open market as any new investor with want a 4% return i.e., pay £50 for a £100 face value gilt paying 2% i.e., £2pa. If it costs you £50 to buy this security, you are receiving £2pa, i.e., a 4% return.
- Gilts are bought by pension funds as they give a guaranteed return to enable pension funds to guarantee paying pension income to their clients that have retired.
- If gilt capital values fall, this means the capital adequacy position for big pension funds is under pressure and they face going bankrupt where liabilities exceed assets.
- The Bank of England buying back gilts with quantitative easing (QE), underpins and drives up capital values which we in turn protect pension funds.
So that was the Bank of England’s stance, saying that they are trying to stabilise the gilt market. In addition, what QE also does is reduce gilts yields i.e., makes it cheaper for the government to borrow more money. This is ‘robbing Peter to pay Paul’.
The Bank of England has said it will continue this temporary QQ position from 28th September to 14th October 2022. This is when the Office for Budget Responsibility is due to issue its report to the Chancellor and we guess at that point decisions will also be made on further interest rate intervention despite the next Bank of England rate decision not due until 3rd November.