What are British gilts? Bank of England actions explained

The Bank of England said it was forced to intervene to stabilize the UK economy after Chancellor of the Exchequer Kwasi Kwarteng’s mini budget

All eyes have been on the UK economy since Kwasi Kwarteng presented his mini budget on September 23. The Chancellor of the Exchequer’s huge tax-cutting exercise, coupled with a lack of measures to raise revenue from the public purse, spooked markets.

The news that the government was going to embark on a huge borrowing program also caused a stir, as it almost led to a run on pension funds – financial institutions that tend to invest heavily in the debt market. public generally stable.

There are major concerns about what will happen when the Bank of England stops buying government bonds (Image: AFP/Getty Images)

So what are gilts – and how did the UK central bank intervene this week? Here’s what you need to know.

What are gildings?

Gilts, commonly known as bonds, are vehicles for borrowing money. It is basically debt in the form of a commodity that can be purchased by a third party in exchange for a particular return over a specified period of years or decades. Investors usually get their money back, plus interest.

While bonds can be issued by private sector companies, the term “gilts” is specifically attached to government borrowings.

Kwasi Kwarteng’s mini budget created market turbulence as the pound plunged (Image: Getty Images)

The reason why probably stems from the term from which the word derives – ‘geld’. In Anglo-Saxon and then Norman times, the geld was a tax paid to the kings and queens of England. Another type of gelding – ‘Danegeld’ – was used to pay off Danish invaders in the late 10th and early 11th centuries.

Geld changed to “golden” sometime in the 1300s, with the new term referring to gold or silver. The modern meaning of the term originated during the reign of William III – or William of Orange (1689 to 1702).

Over the years, this system has evolved so that those who make these loans can earn a certain amount of money from them in the form of interest.

Gilts are generally considered a low-risk form of investment because they are long-term liabilities and come from the government, which can never really go bankrupt.

Nor has the government historically issued large amounts of it at once without a longer-term financial plan or independent forecast – until at least Kwasi Kwarteng became chancellor. This means that the value of gilts has rarely changed at a rapid rate.

What is Bank of England Bond Intervention?

The main roles of the Bank of England are to keep the value of the pound stable and to ensure that the UK economy remains on a balanced keel. Essentially, it protects our purchasing power and ensures that our money is protected when we invest or save it.

When Kwasi Kwarteng’s £45billion tax cuts and Liz Truss’ hefty energy price guarantee bill were announced, it led markets to believe the government was about to launch a major public borrowing exercise. The lack of an Office for Budget Responsibility (OBR) forecast and longer-term government spending plan, as well as the chancellor’s promise that more tax cuts were to come, also sparked criticism. market concerns about new unfunded borrowing.

The Bank of England is trying to support UK financial markets (Image: PA)

This led to a major drop in the value of government securities as investors demanded higher returns for what they felt had become a riskier investment. This meant that pension funds, which buy and trade a significant amount of government bonds, suddenly risked bankruptcy, while the cost of government borrowing was expected to skyrocket.

The situation forced the Bank of England to intervene as it said there was a “significant risk to the financial stability of the UK” as it could lead to “a reduction in the flow of credit to the real economy “. Essentially, the general public’s money and businesses were at risk.

The UK’s central bank has announced that it will buy back £65 billion of government bonds between September 28 and October 14 in a bid to stabilize the market. But with the deadline looming and no economic plan expected from the Chancellor before the end of the month, investor concerns threatened to create further market turbulence.

The struggle of the pound against the dollar following the policies of the Truss government forces the Bank of England to consider interest rate hikes (Image: Getty Images)

On Monday, October 10, the Bank of England doubled its daily bond purchase limit to £10 billion. On Tuesday (October 11), he then followed that exercise up with an expansion of the type of gilts he was buying — adding indexed gilts to his emergency package.

Index-linked gilts are bonds whose value and payouts are determined by the Retail Price Index (RPI) – a measure of inflation calculated by the Office for National Statistics (ONS). They represent about 25% of the gilt market.

The Bank of England said the action was necessary to avoid a “fire sale” (i.e. a rapid sale) of government bonds and “to restore orderly market conditions”. It came after longer-term bond yields — the yields demanded by investors to buy decades-old government securities — soared on Monday.

Although the move calmed markets — for now, at least — commentators said the central bank’s actions suggested it was still in firefighting mode, rather than in control of the situation. Neil Wilson, chief market analyst at Markets.com, said the Bank’s third intervention “seems rather messy and panicked.”

He said: “As expected, the market was always going to re-test the Bank’s resolve and put the budget to the sword. Extending your emergency market intervention once is unfortunate, doing it twice feels like negligence.

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