Bank of England Corners the Gilts Market

The surprise decision by the Bank of England yesterday to increase the ceiling on its Quantitative Easing [QE] program to £175 billion caught many City slickers by surprise and there was an immediate drop in sterling (as seen in the chart above) and an equally abrupt drop in yields in the gilt market.

It turns out that the QE program exactly matches the government's projected deficit this year , or at least the figure that Chancellor Darling last gave to Parliament, and further research shows that in effect the Bank of England now owns the majority of outstanding gilts and has "cornered the market" in Treasuries as this piece from the Daily Telegraph reveals.

So much of the gilts market does the Bank now own that, in a landmark move, it also agreed that it would temporarily lend out gilts through the Debt Management Office to ensure that banks are able to close out positions as necessary.

The Bank has also suspended its purchases of four particular maturities of gilts after it emerged that it had bought as much as 70pc of their total issue. In a further sign of the rate at which it is exhausting the gilt market, the Bank will also start buying gilts of both shorter and longer maturities than the 5 to 25 year set it was originally buying.

Danny Gabay of Fathom Consulting said the news "reflects the fact that the Bank has to all intents and purposes 'cornered' the market for certain Gilts or bonds, to which market participants may still need to have access. Innocent enough - but it makes the charge that the whole [scheme] is an elaborate smokescreen for monetising the government's ballooning deficit even harder to refute.

"So, while we welcome the news of an extension to the asset programme, we would once again urge the MPC to consider a much wider range of assets to purchase than government bonds."

Yesterday's decision means that the Bank will soon own almost half of the entire gilts market, currently worth around £400bn, raising further questions about the Government's reliance on the QE programme to keep its financing under control.

The worrying question must surely be, what about next year's projected deficit which according to the Chancellor is about the same as this year's i.e. £175 billion?

Will the Treasury be able to sell gilts to anyone other than the Bank of England?

Some cynics of my acquaintance are even asking whether this system of completing the daisy chain between the Bank's printing press and the funding of the public finances needs a new moniker as Ponzi scheme doesn't quite fit the bill.

On a cautionary note there will be few wanting to short the gilt market as they will in effect have to ask the Bank of England to lend them the security so they can sell it back to them where the Bank effectively runs the market . We may also need some new terminology to augment our notions of repos and reverse repos.

Comments

[Moon Kil Woong]

To even entertain this as economics is almost laughable except for the fact that it affects millions of people. I would ask if they were out of their minds but alas, I can not say anything because our own government is tiptoing down the same path, abit slower since they essentially have the whole world trying their best to hold their blubbery economic body up.

2009 Aug 07 07:22 AM

[John Lounsbury]

Maybe my history is foggy (how London!), but a couple of centuries ago (maybe more?) wasn't the chief purpose of the Bank of England to finance the government? Maybe a better historian will have better detail than I do.

Anyway, if my sense of history is correct, maybe a new empire will arise since we are back at the starting point of the last one. Or is this simply a case of ashes to ashes and dust to dust? Before anyone takes this seriously, it is an attempt at humor.

2009 Aug 07 07:39 PM

[PainfullyAware]

Central Banks Are Becoming The "Primary Customers" For "Sovereign Debt" Through Direct And Indirect Means.

If it had not been "Such A Party With Financial Engineering" I would believe that this would be a "Valid Short Term Strategy". Since "The Money Hole Of Derivatives" - the initial cause of the "Credit Crisis" - is much larger than the entire worlds GDP combined many times over - I Lack Confidence In This Strategy.

The Benefit of the "Shell Game" is that if you have 3 or more involved you can create money out of nothing almost indefinitely. The Bane of the "Shell Game" is that if only 1 "Disintegrates" All Participants Suffer "The Margin Call" And Domino To Their Own Destruction.

Things Are Not Well.

2009 Aug 08 03:13 AM

[Clive Corcoran]

John
Historically the Bank of England certainly did play a role in helping governments to finance wars, imperial expansion and all kinds of other "good causes" but there was at least the semblance that they were intermediating between other people's money and the government coffers. Now, taking a Hollywood phrase, they just cut to the chase and print what is required to finance the "public" (funny word in some ways) debt.

Perhaps if it doesn't look too good down the road the Fed or the IMF can step in and print some of their money to help out.

Painfully Aware
I follow your reasoning about the shell game. The sniff of a disorderly gilts market in the UK could be the canary in coal mine that shows just how un-manageble it is going to be keep the daisy chain together to sell all the mountains of debt that governments around the world keep taking on.

This could be a job for Milken, Houdini and Madoff working in tandem.

2009 Aug 09 12:52 AM

[Living4Dividends]

BoE is printing money like mad. British economy is heavily in debt. Pound Sterling USED to be the world's leading reserve currency.
So no one will buy gilts - and they have to buy them themselves. Just wait - same thing will happen here.

2009 Aug 09 01:30 PM