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In the final week of its emergency bond-buying program, the central bank is expanding its efforts to restore bond market function.
LONDON — The Bank of England stepped up its intervention in Britain’s bond market on Tuesday, the second expansion of its emergency measures in two days, as it warned of a “material risk” to the nation’s financial stability from dysfunction in part of the market.
For the past two and a half weeks, Britain’s financial markets have faced turmoil after investors rebuffed the tax-cutting and spending policies of Prime Minister Liz Truss and her new government. Economists have widely condemned the policies over concerns they will stoke inflation, which is already near a 40-year high, and require large amounts of borrowing as interest rates rise. The pound dropped to a record low and bond prices fell, which caused bond yields to surge, leaving many Britons facing higher mortgage rates. On Tuesday, the International Monetary Fund said the government’s policies were “complicating” the central bank’s fight against inflation.
The sharp rise in bond yields, especially for bonds with long maturities, left an investment strategy used by pension funds in disarray, as they were forced to sell bonds to raise cash for collateral. It was so bad that the Bank of England felt compelled to intervene by offering to buy government bonds, and postponed its plans to sell off its debt holdings back to the market.
Initially, this helped bring bond yields down and the central bank said the funds had made progress in improving their resilience to the volatility in the market. But tumult has returned as traders wonder what will happen when the bond-buying operation ends on Friday.
This week there has been a “further significant repricing” of government bonds, especially for inflation-linked bonds, the central bank said on Tuesday.
“Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics, pose a material risk to U.K. financial stability,” it added in a statement.
The bank said it still planned to end the bond-buying on Friday but would add inflation-linked debt to the assets it was willing to buy — up to 20 billion pounds — in the final week of the program. On Tuesday, it bought just under £2 billion of inflation-linked bonds, and about £1.4 billion of conventional government bonds, known as gilts.
At a conference in Washington on Tuesday, Andrew Bailey, the governor of the Bank of England, was firm in saying the bond-buying operation will end on Friday.
“We have announced that we will be out by the end of this week,” he said. “And my message to the funds involved and all the firms involved in managing those funds: You’ve got three days left now. You’ve got to get this done.”
After he spoke, the British pound dropped sharply against the dollar, falling from just under $1.12 to below $1.10. The bond market had already closed for the day.
The central bank expanded into inflation-linked debt just a day after other efforts by the bank and government to ease strain in markets.
Britain’s government said on Monday that the date for its next fiscal policy announcement would be moved up nearly a month and that it would provide, at the same time, a much-anticipated independent assessment of the policies’ impact on the nation’s economy and public finances.
The chancellor of the Exchequer, Kwasi Kwarteng, said he would publish his “medium-term fiscal plan” on Oct. 31, which would show how the government would bring down debt levels despite large spending plans and tax cuts that would be funded by borrowing.
New economic and fiscal forecasts from the Office for Budget Responsibility, a government watchdog, are to be published the same day.
On Monday, the Bank of England tried to address a continuing dysfunction in bonds. It said it would expand its intervention in the bond market by increasing the size of the daily auctions in a bond-buying program and setting up other facilities to improve liquidity for the pension funds.
Over the first eight trading days of the bond-buying operation, the bank said Monday, it had bought only about £5 billion of long-dated government bonds, despite setting a limit of £5 billion a day. Before the program ended, it would increase the auction sizes and set up a new collateral facility to try to ease liquidity problems faced by the pension funds, which will continue beyond this week.
Even with the interventions, the yield on long-dated government bonds have kept rising, climbing to 4.8 percent on Tuesday, once again approaching highs seen during the worst of the bond rout after the last fiscal statement.
Mr. Bailey said on Tuesday that he and the deputy governor for financial stability, Jon Cunliffe, had been “up all night” on multiple occasions trying to solve the problem in the bond market. “In the end, we couldn’t make a targeted intervention,” Mr. Bailey said.
The Pensions and Lifetime Savings Association said on Tuesday that the central bank’s early intervention had been generally effective, but “recent days have, however, shown that market confidence remains low.” It urged the bank to not end the bond-buying operation too soon, and said many pension funds felt it should be extended at least until the end of the month.
The market turbulence continues amid skepticism that the government’s plan would expand the economy as promised, and that instead large public spending cuts would be necessary.
The I.M.F. reiterated its warnings about the British government’s policy on Tuesday. As it slashed its forecasts for global economic growth and said inflation would be more persistent than previously expected, it said Britain would also experience a “significant slowdown.” Even though the government’s policies might protect growth somewhat, they are also “complicating the fight against inflation,” the Washington-based organization said in a statement.
“We’ve seen a lot of turbulence in the gilt market of late,” Pierre-Olivier Gourinchas, the I.M.F.’s chief economist, said at a news conference, adding that fiscal policy needs to be aligned with the goals of monetary policy.
“It’s like having a car with two people in front and each of them has a steering wheel and is trying to steer the car in a different direction,” Mr. Gourinchas said. “That’s not going to work very well.”
Jeanna Smialek contributed reporting from Washington.