Threadneedle Street will spell out on Wednesday how it plans to get reluctant investors to part with government bonds – also known as gilts – in order to provide additional stimulus to the economy under its new £60bn quantitative easing (QE) programme.
The Bank enacts its electronic money-printing exercise – which was launched in March 2009 and was one element of a stimulus package to kickstart the economy announced last Thursday – by buying gilts.
One of the other key measures – a quarter-point cut in interest rates to 0.25% – has also run into problems, with some high street banks unwilling to pass on fully cheaper borrowing costs to their customers.
The Bank offered on Tuesday to buy back £1.17bn of long-dated gilts – those with a maturity of 15 years or more – but received offers of only £1.11bn, leaving it with a shortfall of £52m. It is the first time since the Bank started buying back bonds that it has failed to attract enough sellers.
Jason Simpson, a UK rate strategist at French bank Société Générale, told Reuters: “It is a little surprising that this comes on the first week ... it is quite early in the whole process, which will be a worry for the Bank of England.”
The unexpectedly low uptake of the buyback offer sparked a sharp reaction in the market, with yields on long-dated government bonds falling to record lows. Yields fall when the prices of bonds rise and push down the rate at which the government pays to borrow from major City investors.
Yields on 20-year gilts slumped to 1.2%, while those on 30-year bonds fell to 1.36%, in the anticipation that the Bank will hike the price it is prepared to pay investors to buy back the gilts.
Daniela Russell, a bond strategist at Legal & General Investment Management, said: “It is going to be interesting to see how the Bank of England responds.”
While Threadneedle Street could increase the price, it could also decide to increase the amount of gilts it attempts to buy at next week’s buying window.
The fact the buyback has begun during the traditionally quiet month of August may explain the low result, bond experts said, adding that it was too early to conclude that pension funds – the traditional buyers of such long-dated gilts – were reluctant to sell.
Stuart Edwards, a global bond fund manager at Invesco Perpetual, said he was not overly concerned by the shortfall. He pointed out that a buyback of shorter-dated bonds the previous day had been “well covered” – the Bank received offers of more than three times the amount it wanted to buy.
There are two ideas behind the Bank buying the bonds: to stimulate economic demand by encouraging the banks and financial institutions selling the gilts to use the proceeds to boost lending to households and businesses or invest in other assets; and to force down the cost of borrowing for the government by increasing demand for bonds, thus increasing their price.
The latest QE plan is part of a four-pronged strategy to tackle an expected slowdown in the economy caused by the vote to leave the EU.
Along with the cut to interest rates, the Bank is also creating another £10bn in electronic cash to buy corporate bonds. It is also trying to encourage banks to pass on the interest rate cut by offering as much as £100bn of new funding to banks. Under this “term funding scheme”, the Bank will create new money to provide loans to banks at interest rates close to the base rate of 0.25%.
The Bank has admitted that rates could fall to as low as 0.1% – but not zero or negative – if the economy falters. There could also be further QE.
The Bank launched QE, announcing £75bn of newly created money to buy bonds, when it also cut interest rates to a then record low of 0.5% in 2009. Over the following three years it expanded QE five times, hitting £375bn in July 2012 when the UK faced a prolonged double-dip recession.
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