Bank of England on alert over new pension threat from bond market turmoil

The Bank of England is poised to intervene as last week’s bond market chaos continues – as beleaguered Governor Andrew Bailey faces further embarrassment.

The Old Lady was forced to step in last autumn to save the pension sector from collapse with the promise of a £65bn package following an earlier episode of bond market turmoil following Liz Truss’s ill-fated mini-Budget.

This time, the sell-off in gilts – British government bonds or IOUs – is being placed squarely on Bailey’s doorstep.

He has been accused of failing to curb inflation and trying to pass off rampant price increases as a passing phenomenon that would correct itself.

The Bank has raised interest rates ten times in a row to keep inflation under control. But last week’s higher-than-expected figure of 8.7 percent — well above the bank’s 2 percent target — spooked investors and spurred them to sell gilts. “Bailey is not well equipped to deal with the major monetary policy crisis we are currently experiencing,” said Andrew Sentance, a former member of the Bank’s interest rate committee, which sets rates.

“We are paying the price for the Bank’s slowness [and] they don’t properly recognize their role,” he added.

Tory MP and former Commerce Secretary Liam Fox said: “The Bank of England has failed to monitor inflation and has maintained loose monetary conditions for too long.”

Experts warn that any further increase in the base rate of 4.5 percent could break the pension industry, while further hurting the 1.3 million homeowners who would re-mortgage this year.

Traders expect a series of rate hikes by the end of the year, bringing the official cost of borrowing to 5.5 percent.

But experts fear this could send further shockwaves through the markets. “It is clear that the financial system cannot yet handle such high interest rates,” said Althea Spinozzi, senior fixed income strategist at investment bank Saxo. “The Bank of England has a big problem.”

The government issues gilts to fund its loans. They are also seen as a measure of confidence in the economy. Traditionally, they are considered one of the safest investments.

Ten-year government bond yields — a measure of government borrowing costs — hit 4.42 percent on Friday, within a fraction of their all-time high after last year’s Truss mini-budget that decimated pension funds.

The Bank is known to be closely monitoring developments – in line with its financial stability mandate. It declined to comment on whether it should step in and rescue the pension sector again if the recent turmoil continues. Bailey, pictured, admitted to MPs last week that there were “very big lessons to be learned” in setting monetary policy after the central bank failed to forecast the recent rise and continued inflation.

The bank’s own forecasting model failed to yield accurate results, the governor added. The latest swings in the bond market came after the International Monetary Fund revised its forecasts for the UK economy following its annual financial health check, as revealed in last week’s The Mail on Sunday.

The IMF said the UK economy will now avoid recession this year.

But last week Chancellor Jeremy Hunt suggested a recession would be a price worth paying if further interest rates were needed to curb inflation.

Renewed bond market turmoil is once again putting the spotlight on supposedly safe, liability-driven investments (LDIs).

These are used by pension funds to back up their promise to pay future pension benefits to some 10 million participants. LDIs came loose when the sudden rise in government bond yields last year revealed that previously hidden leverage – or borrowing – was lurking in the pension system.

Some £545 billion, almost 30 per cent, was wiped from the value of occupational pension schemes last year following an asset sell-off due to the mini-budget.

Analysts say pension funds using LDIs should be better able to withstand the latest bond market slump after being instructed by regulators to build buffers of “rainy day” cash to cushion future shocks.

They also note that the increase in gilt revenue has not been as rapid or extensive as last time.