Britain’s bond market turmoil

LONDON (Reuters) – British government borrowing costs hit a 20-year high on Wednesday after Bank of England Governor Andrew Bailey told pension funds they had three days to fix liquidity problems before the bank withdrew emergency bond-buying support.

The country’s financial markets have been in turmoil since finance minister Kwasi Kwarteng last month unveiled tax cuts with no details of how they would be paid for.

Following is a snapshot of related events, comments and explanations:

WHAT’S BEHIND THE CRISIS?

* The Bank of England has been forced into emergency bond-buying to stem a sharp sell-off in Britain’s 2.1 trillion pound ($2.3 trillion) government bond market that threatens to wreak havoc in the pension industry and increase recession risks.

* The sell-off began after Kwarteng’s tax-cut announcement.

* The BoE interventions have highlighted a growing segment of Britain’s pensions sector – liability-driven investment.

* LDI helps pension funds use derivatives to “match” assets and liabilities to avert risks of shortfalls in payouts, but the soaring interest rates have triggered emergency collateral calls for those funds to cover the derivatives.

MAJOR PLAYERS

* BoE governor Bailey said on Tuesday on the sidelines of an IMF meeting in Washington that BoE support for the pension funds would end as planned on Friday.

* A BoE spokesperson said on Wednesday it had been made “absolutely clear” to banks at senior levels that the deadline would hold, after the Financial Times cited sources as saying it might be extended.

* Prime Minister Liz Truss said on Wednesday she would not cut public spending after her government came under pressure to fund the tax cuts. She also dismissed calls for an early election.

* The BoE’s chief economist, Huw Pill, said credible fiscal policy was needed as the BoE tries to rein in inflation, which is near a 40-year high at 9.9%. He said a “significant” monetary policy move was likely at the BoE’s Nov. 3 meeting. Markets are pricing in a 1 percentage point hike interest rates to 3.25%.

* The pensions regulator said employers could have been called on to bail out pension schemes had the BoE not intervened.

MARKET REACTION

* The 20- and 30-year UK government bond yields both hit their highest since 2002 at 5.195% and 5.1% respectively, passing above 5% for the first time since the BoE began buying bonds on Sept. 28 to calm the turmoil.

* Sterling, which had dived against the dollar after Kwarteng’s tax cut announcement, dipped to a two-week low after Bailey’s remarks, before rising by 1% on Wednesday.

* Craig Inches, head of rates and cash at Royal London Asset Management, said: “To a global investor the UK looks a mess and therefore global investors don’t want to step in and buy yields at attractive levels until the UK gets its house in order.”

(Compiled by John Stonestreet and Catherine Evans; Editing by Alex Richardson and Alexander Smith)