UK cliff edge arrives as Bank of England prepares to end bond buying

LONDON — The Bank of England‘s emergency bond-buying program draws to a close on Friday, with traders remaining on edge as volatility in the U.K. bond market looks set to continue.

The central bank initially announced the two-week intervention in the long-dated bond market on Sep. 28, having been informed that a number of liability driven investment (LDI) funds — held by pension plans — were hours from collapse as U.K. government bond prices plunged.

The market volatility was triggered by the British government’s so-called “mini budget” on Sep. 23, which prompted widespread backlash over billions of pounds of unfunded tax cuts while spooking both bond markets and the British pound.

Finance Minister Kwasi Kwarteng will now deliver an updated medium-term fiscal plan on Oct. 31, the same day the Bank of England has earmarked to commence selling gilts as part of its wider monetary tightening efforts.

Kwarteng cut short a visit to the International Monetary Fund in Washington Thursday, flying back to the U.K. as the government convened to address the country’s economic crisis. Reports suggest that a U-turn on the mini-budget’s £43 billion of unfunded tax cuts could be imminent.

The Bank’s Monetary Policy Committee then meets on Nov. 3 to determine its next move on interest rates, and Chief Economist Huw Pill has indicated that the country’s new fiscal framework will necessitate a “significant” monetary policy response as policymakers look to rein in sky-high inflation.

Prime Minister Liz Truss’s government maintains that its sole focus is achieving 2.5% annual GDP growth, but the focus on fiscal support for the economy means Downing Street and Threadneedle Street are pulling in opposite directions, with the Bank of England trying to tighten its belt to cool the economy and contain inflation.

The BOE’s Pill also highlighted that recent actions taken to ensure orderly market function and financial stability sought to preserve the effectiveness of monetary policy, but should not be considered monetary policy actions in themselves.

Bond yields, which move inversely to prices, soared again on Wednesday after Bank of England Governor Andrew Bailey confirmed that emergency support mechanism would be withdrawn on Friday, leaving LDIs with around 72 hours to shore up their balance sheets. The 30-year gilt yield hit 5% for the first time since before the Bank’s historic intervention.

With gilt turbulence expected to persist at least until the government’s fiscal update, some economists expect the market to force more targeted assistance from the Bank in the coming weeks.

“It’s very probable that the Bank of England will resume repurchases because two and two doesn’t equal 22 – it is virtually impossible to wash out the massive amount of negative yielding bonds in the pension funds’…