The aftermath of the mini-budget might have resulted in a £50 billion firesale of UK government bonds by pension funds, according to the Bank of England.
It was stated that there was a potential for a downward “spiral” as the cost of government borrowing increased.
The Bank feared that these funds would be obliged to sell their holdings of government debt, aggravating market volatility.
The cost of borrowing hit record highs for two consecutive days, according to the Bank.
The increase in interest rates over the course of four days was “three times greater than any other historical change.”
Last week, the Bank intervened to calm markets following concerns that some types of pension funds were at risk of collapse.
It vowed to purchase up to £65 billion of government bonds after the mini-budget shook financial markets and caused the pound to fall.
Investors had demanded a considerably larger yield on government bonds, causing some of them to lose half of their value.
Using data beginning in 2000, the Bank reported that the market for long-term loans to the government lasting three decades, known as 30-year gilts, had two days of record spikes in the effective cost of borrowing.
John Cunliffe, the Bank’s deputy governor, sent a letter to the Treasury Select Committee containing a diagram depicting the cause of the interest rate shock as the “fiscal event,” another term for the mini-budget, and stating that the nature of the move in the United Kingdom was not observed in the United States or the eurozone.
In a speech on Thursday, Jonathan Haskell, a member of the Bank’s Monetary Policy Committee, stated that “there was a UK-specific aspect” in the market turbulence.
This contradicts the assertions of some government supporters that last week’s instability was driven by “global circumstances” and not the mini-budget.
The Office for Budget Responsibility (OBR), the UK’s independent economic forecaster, offered to create a draught forecast in time for the mini-budget, but the government declined.
Mr. Haskell said that the Bank uses OBR data in its predictions and that a “sidelined” OBR “increases uncertainty by diminishing everyone’s information base.”
The Bank feared that funds tied to the pensions industry, known as Liability Driven Investments, would be compelled to abandon their holdings of UK government debt in a market that was already shaky.
A £50 billion sale would have increased the effective cost of borrowing, or yield, considerably higher than 5%, resulting in daily difficulties. Before the mini-budget, this yield stood at approximately 3.7%.
Individual defined benefit pension funds were not in jeopardy since they are guaranteed by the sponsoring corporation, but the situation may have posed a threat to the financial stability of the economy as a whole.
Last Wednesday, the Bank of England decided to interfere in the market, reducing the effective borrowing cost from almost 5% to less than 4%.
As a result of the Bank’s decision to reduce its interventions, these prices increased significantly on Thursday, reaching 4.4%. These rates contribute to the expense of long-term mortgages and commercial loans.
The Bank’s emergency intervention is scheduled to conclude next week, and so far it has only spent £3.7bn on a fraction of the government bonds it could have purchased.
The Bank announced on Thursday that it will reduce its bond purchases in a “smooth and orderly” manner if it determined that the market was once again functioning regularly.
The Bank also stated that it is collaborating with the UK’s pensions and financial regulators to ensure that some pension plans’ investment strategies can survive market volatility.
