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British central bank intervenes and prevents collapse of pension funds with emergency intervention

2022-09-29T15:00:14.775Z

In a spectacular emergency operation, the British central bank has announced that it will buy up massive amounts of British government bonds. Apparently she saved British pension funds from collapsing - at least for the time being. A reconstruction.



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Rescuers in need: The British central bank had to intervene massively in the market for British government bonds.

The plans of Prime Minister Liz Truss and her Chancellor of the Exchequer Kwasi Kwarteng had previously whipped up yields and caused turmoil on the financial markets

Photo: ISABEL INFANTES / AFP

The warning sounded factual, but its urgency could hardly be underestimated: The British central bank is following developments on the financial markets very closely in view of the "significant revaluation" of British financial assets, the statement by the monetary authorities began on Wednesday.

Should the "disruptions" in this market continue or worsen, "there would be a significant risk to the financial stability of the UK".

In order to "restore the functionality of the markets", the bank will buy up massive amounts of long-dated British government bonds.

"I thought this was the beginning of the end," the Financial Times quoted a veteran London banker as saying on Wednesday.

There were no buyers for long-dated UK government bonds on Wednesday morning.

"It wasn't quite a Lehman moment. But it was close," the banker described the dramatic situation to the FT.

As the Bank of England put it in vague terms: the collapse of the pound sterling and British government bonds, yields of which shot up to record highs on Wednesday, had shaken British pension funds and with them the entire pension system on the island.

Hedging strategies threatened to fail

Large pension funds dominate the long-term government bond market in the UK.

The problem: The hedging strategies used by thousands of pension funds to protect pensioners from inflation and interest rate risks were in danger of failing completely in view of the recent rally in government bond yields.

In the long run, lower bond prices and higher yields are good for pension funds.

Because they help them to generate the necessary income for the retirees.

In normal times, when gilt yields - the interest rates paid on government bonds - are rising, the funds may need to sell some of their assets to balance their hedging strategies.

Carefully and in an orderly manner.

In the event of short-term, rapidly increasing risk premiums, as in the past few days, hedged positions must be backed with additional collateral.

Apparently, this forced UK pension funds to sell assets in a hurry to remain liquid and to meet their payment obligations.

They also had to part with bonds, which accelerated the downward spiral, as the "Financial Times" and Bloomberg analyze in a series of articles.

The new government's plans are forcing the central bank to intervene

The dramatic development on the bond and foreign exchange markets had triggered a package of measures worth billions announced five days earlier, with which the new British government intends to combat high inflation and boost the British economy.

Treasurer Kwasi Kwarteng announced both higher government spending and tax cuts - at the price of a rapidly rising national debt.

When asked, Karteng added that he really didn't care about the reaction on the financial markets: the market could react as it wanted.

And so did the market.

"The movements in yields at the long end were downright unbelievable. The gilt market was in freefall," said Daniela Russell, rates strategist at HSBC, outlining the dramatic development since the beginning of the week.

British pension funds, in their distress, increased the pressure on the government to intervene.

In fact, UK government bond markets rebounded significantly after the central bank's announcement.

The pound strengthened against other currencies such as the dollar.

Kwarteng and Truss under pressure

"If no action had been taken today, yields could have soared to between 7% and 8%. In this situation, around 90% of UK pension funds would have run out of collateral," said Kerrin Rosenberg, managing director of Cardano Investment.

"They would have been destroyed."

After the emergency intervention by the central bank, the question of whether Kwarteng should still be retained as British treasurer is being discussed in the financial center of London.

Individual experts explained that it was not a self-inflicted crisis of British pension funds and thus of the British pension system.

"This is purely a liquidity issue - the pension funds are solvent," Jim Leaviss, chief investment officer at M&G Investments, told Bloomberg.

According to him, the Bank of England intervened out of "fear that this could become a systemic problem".

He sees the responsibility clearly with the new British government.

Such measures have been taken in the past during the financial crisis or the corona pandemic - but never "to limit the effects of your own government's budget plans," said the German-British economist Andrew Lee from the Baden-Württemberg Cooperative State University in Baden-Württemberg Karlsruhe.

"This is completely unprecedented," he commented.

The Bank of England stressed that purchases of long-dated government bonds with a remaining maturity of more than 20 years would be "strictly limited" in time - specifically until October 14 and capped at a total of 65 billion British pounds, according to a further statement on Wednesday explained .

Pension funds are buying time, but the crisis is not over

The central bank's intervention should give pension funds time to replenish their collateral in an orderly manner and with less pressure, some analysts said, according to the reports.

The Pensions Authority welcomed the Bank's intervention but urged pension plan trustees to review the resilience and liquidity of their investments and risk management.

However, the pound sterling crisis and the turbulence surrounding British government bonds will not be permanently resolved with a temporary intervention.

The central bank had previously sold bonds - and completed a U-turn with the purchase program that has now been announced.

With the purchase program, the inflationary risks in Great Britain continue to rise, and to a considerable extent.

Those risks will only diminish if the government changes course on tax cut plans, said Mike Riddell, a bond portfolio manager at Allianz Global Investors.

However, it doesn't look like that at the moment.

At the same time, the investment strategist was skeptical: "Yesterday the central bank told the market that it would take a very restrictive stance, and today it is buying government bonds again. What is initially seen as temporary may prove to be permanent."

If this is the case, the British pound will get into quite different difficulties.

rei

Source: spiegel

All news articles on 2022-09-29

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