(Bloomberg) – Chancellor of the Exchequer Kwasi Kwarteng said the Bank of England will be responsible if UK markets suffer renewed volatility after its bond-buying program ended on Friday.
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Speaking on the sidelines of the International Monetary Fund’s annual meeting in Washington, Kwarteng told Sky News that any turmoil following the withdrawal of central bank support was “a matter for the governor”.
Kwarteng and the UK government are preparing to make BOE chief Andrew Bailey the scapegoat for the turmoil that could hit Britain next week if ailing pension funds at the heart of this month’s sell-off fail to liquidate their positions and get the cash they need by the end upset this week.
Bailey has given the funds two more days to use the bank’s £65 billion ($72 billion) emergency backstop facility before the scheme closes. The tough deadline increases the risk of further market chaos, which could cause some so-called liability-driven investment strategies to fail and would pressure Kwarteng to present a revised set of tax and spending plans.
Since Kwarteng unveiled a £45bn package of unfunded fiscal stimulus on September 23, markets have been in a maelstrom from the IMF and the bank itself that the package risks adding to inflationary pressures.
Bailey this week underscored his determination to halt government bond buying as planned on Friday, both to end a program that is complicating his efforts to tame inflation and to encourage pension funds to continue to close their positions.
Read more: Bailey risks BOE’s credibility in vow to end Gilt purchase
Traders will be eagerly watching Thursday’s call to see if the funds listened. On Wednesday, the BOE bought £4.4 billion worth of gilts in its largest intervention since the package was launched on September 28. Market conditions improved dramatically after the BOE move.
Even bigger buying in the final two days of the operation suggests the funds are hastily clearing their positions in preparation for the backstop lifting. The BOE is offering to buy up to £10 billion worth of bonds on Thursday and Friday.
When the bank launched government bond purchases to avert a sell-off in UK assets, it stressed that the intervention was a financial stability operation. The problem is that the policy is a copy of quantitative easing – an earlier attempt to buy bonds to stave off deflation – and this has confused the bank’s signals as it tightens monetary policy by raising rates and focusing on prepared to sell government bonds.
Bailey wants to put an end to this confusion and restore market discipline by arguing that it’s not a central bank’s job to bail out pension funds.
What happens next?
Asset managers, regulators and bankers at the Institute of International Finance meetings in Washington were divided on how the next few days will play out.
Thilo Schweizer, head of Europe at Commerzbank, said they were skeptical that Bailey would be able to keep his post. “The market could test him, and when they do, he’ll eat his own words,” Schweizer said.
Should the BOE reverse Bailey’s promise to stop buying government bonds, it would raise credibility issues at a time when the government’s own loss of credibility is at the heart of the market chaos.
Others said the BOE should no longer jeopardize its independence by covering up problems created by the government, but instead step aside and force the Treasury to act. Senior Tories are also urging the Chancellor to rip up his mini-budget to avoid a financial crisis.
Katherine Garrett-Cox, managing director of Gulf International Bank of Bahrain’s UK subsidiary, said: “There is no silver bullet for this. The bank must stay within the guard rails – its framework and its long-term policy mechanism.”
Steven Major, head of fixed income research at HSBC, said another option to ease the tightness in the markets is for the Debt Management Office, which is part of Kwarteng’s Treasury Department, to change its funding plans. If the DMO chose to borrow very short-term money – a part of the gilt market that does not have demand problems – it could help ease tensions on longer-term debt enough to avoid another defeat.
And maybe the router just doesn’t come off. The funds still have two days of emergency liquidity support to help them clean up their portfolios, and after that the BOE also has a number of standard liquidity programs that can be used when pension funds need cash.
Still, a senior financier warned that relying on that result was a risky proposition. They pointed out that these programs require funds to be channeled through commercial banks, and that these lenders may be uncomfortable taking even temporary risks on their balance sheets.
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