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Why has Bank of England stepped in again and how will market turmoil affect me?

The Bank has made a second move in as many days to bolster its emergency bond-buying programme after a renewed bout of market turbulence.

11 October 2022

The Bank of England’s fresh attempt to soothe market chaos followed another punishing day for the pound and UK government bonds amid worries over the Government’s mini-budget plans.

It marks the second move to bolster the central bank’s emergency bond-buying programme in as many days after a renewed bout of market turbulence, despite the Chancellor also moving forward plans to outline his financial strategy and independent economic forecasts to October 31.

Here we look at what sparked this latest market rout and what it means for UK households.

– Why has the Bank stepped in with more emergency action?

The Bank said it needed to broaden the emergency programme to buy UK government bonds – also known as gilts – to calm markets as it warned over a “material risk to UK financial stability”.

It came after a further sell-off in the gilt market, which saw the yields on long-dated government bonds rise back up close to levels seen in the immediate aftermath of the mini-budget.

– What are gilts and gilt yields?

UK government bonds are a way for the Government to raise money.

A gilt is essentially an IOU that the Treasury writes to its lenders, promising to pay the money back, plus interest, within a time frame, for example over two, 10 or 30 years.

The yield on a gilt is the amount of money an investor receives for owning the debt and is represented as a percentage of its price. When a bond price falls, its yield rises.

Yields fall when investors are less willing to own the debt, meaning they will pay a lower price for the bonds.

– Why are bond yields rising?

Concerns over the Chancellor’s plans for unfunded tax cuts sent gilt yields soaring as markets fretted over the Government’s economic policies.

At one stage, the yield on 30-year gilts hit levels not seen since 2002 in the chaos that followed the mini-budget statement, while the pound also plunged to record lows against the US dollar.

– What do gilt prices have to do with pension funds?

Pension funds invest huge amounts of money in gilts, which are seen as safe investments in usual times.

In order to protect themselves against sharp rises in Government borrowing costs, funds have been investing in products that act as a kind of insurance – so-called liability driven investment (LDI) funds.

But due to the sudden rise in Government borrowing costs after the mini-budget, investment banks called on these LDIs to put up assets or cash as securities for loans, which in turn called on pension funds, forcing them into a fire sale of gilts, driving prices still lower and yields higher and creating a downward spiral.

– How bad is the latest crisis in financial markets?

The Bank warned last week that it had been been forced to step in to avoid market meltdown, when some pension funds were left close to collapse and there was a risk of a knock-on impact elsewhere in the financial system.

Its measures initially eased pressure on gilt yields, but they spiked higher again and there are signs the woes may be spreading elsewhere, to index-linked gilts, as well as corporate bonds and even in niche debt markets in the US.

– Will my pension be affected?

Experts say the gilt rout, which is largely affecting final salary and defined benefit pensions schemes, will not impact policyholders.

The Pensions and Lifetime Savings Association (PLSA) said: “Although there has been a great deal of commentary over the last few weeks, members of defined benefit pension schemes should be reassured that their pension benefits are safe; scheme funding is strong and, despite the operational challenges, funding will have been strengthened further by rising yields.”

– Why are mortgage rates rising?

Higher gilt yields and the prospect of rising interest rates as the Bank looks to cool rampant inflation have a significant impact on mortgage lenders.

Rates on two and five fixed year deals have gone past 6% for the first time in many years due to the market turmoil, while lenders have also been pulling hundreds of products.

– Will the latest action be enough?

There are concerns that when the Bank’s programme comes to a close on October 14, there will be a further sell-off of gilts, leaving pension funds in chaos once more.

The PLSA has called for the bond-buying programme to be extended to the Chancellor’s next fiscal statement on October 31 or even beyond, suggesting there may yet be further intervention from the Bank.

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