Bank of England to face 'real trial' to implement monetary stimulus, say analysts

Experts said pension funds would be reluctant to sell long-dated Gilts, even at the high prices offered by the Bank, because of regulatory requirements

A Bank bid to buy Gilts came up short on Tuesday (Getty)

It could be a “real trial” for the Bank of England to implement its £60bn government bond-buying programme to stimulate the economy in the wake of the Brexit vote, market analysts have predicted.

The Bank sought to buy £1.17bn of long-dated government bonds, or Gilts, on Tuesday but unexpectedly missed this target by £52m, raising doubts about whether Threadneedle Street will be successful in implementing its latest round of money-printing stimulus known was quantitative easing.

Marc Ostwald of ADM Investor Services said pension funds would be reluctant to sell long-dated Gilts, even at the high prices offered by the Bank, because of the regulatory requirements on them to match their long-term liabilities with safe long-term assets.

“Lots of people in the pension fund sector are always going to be forced buyers due to regulation. They’re unwilling to sell the paper they’ve got because they’re going to be chasing their tail. I can see this being problematic throughout,” he said. “I’m not saying it’s going to fail every week, but it’s going to be a real trial.”

Mr Ostwald also said there might be pressure for the Treasury and regulators to revise their regulatory requirements on institutions. “The pension funds will say ‘either you ease up on our asset-liability matching or accept that we aren’t going to sell to you’.”

"The pension funds will say ‘either you ease up on our asset-liability matching or accept that we aren’t going to sell to you’ "

&#13; <p>Marc Ostwald</p>&#13;

Mr Ostwald does not think that the latest six month QE programme will be abandoned since that would be a catastrophic “admission of failure” from Threadneedle Street but he does think the Bank will need to work much more closely with the Treasury’s Debt Management Office, which sells government debt, in future.

Darren Bustin, head of derivatives at Royal London Asset Management, also said there could be further difficulties for the Bank. “With plummeting government bond yields and pension schemes desperate not to increase deficits further, we could well see more bond purchase failures, with low coverage ratios a likelihood for some time” he said.

“The Gilt market is reaching the point where existing QE has diminished the available supply of Gilts from potential sellers [and] we may be reaching the end of QE as a sustainable policy tool” said Danny Vassiliades of Punter Southall.

"The gilt market is not functioning as an efficient market, as one huge buyer [the Bank of England] is having a big distorting effect on prices."

Gilt purchases by the Bank are designed to stimulate the economy through a “portfolio effect”.

The theory is that asset managers will sell their Gilts for a profit to the Bank and then feel the need to replace them with corporate bonds.

"We could well see more bond purchase failures"

&#13; <p>Darren Bustin</p>&#13;

These purchases will push up the price of these assets and depress the yield, effectively making it cheaper for companies to borrow. This is then supposed to stimulate investment by firms and boost GDP.

Analysts said that the problem facing asset managers was that after selling their long-dated Gilts they needed to find decent assets that would retain their value to replace them, and this was increasingly difficult as nervous investors plough money into all manner of bonds.

"They're asking: 'will I have to overpay to replace it [the Gilt]?' " Mr Ostwald said.

The Bank last week also announced plans to buy £10bn of corporate bonds directly as part of its latest stimulus package.

But Mr Ostwald warns there could be potential problems for the bank executing this too, due to the relatively small size of the eligible market, estimated by the Bank to be around £150bn.

However, the Bank of England is confident it will be able to fulfil all its targeted bond purchases, explaining Tuesday’s shortfall by pointing to traditionally thin trading in August and the fact that key decision-makers in asset management firms might be on holiday. It said today that it would make up the £52m shortfall in the second half of the six-month buying period.

The Bank also successfully bought £1.17bn of Gilts maturing in 7 to 15 years, at a strong offer-to-cover ratio of 4.71 yesterday.

Officials expect the price mechanism of its “reverse auctions” to work. In reverse auctions the Bank states the value of Gilts, of a certain maturity date, it would like to buy from the market on a given day and then watches what offers come in. It then buys at the best offered price, while reserving the right not to purchase if it thinks the prices demanded are excessive.

Some independent analysts are also more sanguine about the prospects for the bond-buying programme.

“My sense is that they’re not a reason to expect the Bank not to be able to implement an extension [of QE]. It’s just a question of finding the right market price” said Jonathan Loynes of Capital Economics.

Mr Loynes also dismissed the idea that there could be an insufficient stock of Gilts in the market for the Bank to buy. “If you look at the Bank’s share of the Gilt market they are not going to come up against the limits” he said.

Before the latest round of QE, the Bank held £375bn of Gilts, out of a total of £1,436bn in issuance. Last week the Bank estimated that there are around £100bn of short-dated Gilts in the market that it could buy, £68.6bn of medium-dated Gilts and £221.7bn of long-dated Gilts.

The Bank is expected to divide its additional £60bn of Gilt purchases between the three categories.

Strong investor demand for three and four-year Gilts yesterday pushed their yields marginally negative for the first time since the UK’s vote to leave the EU.