Bond investors shrug at BoE’s direct-financing move

Bond investors say they are relaxed about the Bank of England’s move to directly finance state spending — as long as it does not become a permanent feature of government financing.

The UK government on Thursday announced it was expanding the size of its own bank account at the central bank, known as the “Ways and Means Facility”, allowing it to bypass bond markets as it increases spending to counter effects of the coronavirus crisis.

There was little reaction in bond markets to the announcement, with 10-year gilt yields little changed at 0.35 per cent in the immediate aftermath. Investors said they were reassured by the government’s assertion that direct financing of the state by the BoE would be “temporary and short-term.”

“I see this as an overdraft facility, not long-term financing with lasting ramifications for the debt level,” said Mark Dowding, chief investment officer at BlueBay Asset Management.

The BoE has been sensitive to accusations that it has resorted to so-called monetary financing — a term associated historically with countries such as Zimbabwe that have unleashed hyperinflation by effectively printing money to pay for government expenditure. BoE governor Andrew Bailey wrote in the Financial Times just a few days ago that the central bank has not embarked on “a permanent expansion of the … balance sheet with the aim of funding the government.”

The Ways and Means Facility, which normally stands at £370m, can now rise to an unspecified amount. During the 2008 financial crisis, it briefly climbed to £20bn. 

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Barclays fixed-income strategist Moyeen Islam said that while the increase is largely a technical measure, “it does open to the door to the claim that the government is now being directly financed by the central bank”. He added: “Recent experience tells us that what is temporary can often become permanent and expand.”

Thursday’s move highlights the government’s huge financing needs as it seeks to fund new spending measures such as its job retention scheme. Gilt issuance is expected to increase sharply, with the debt management office already tripling its bond sales in April to £45bn.

Investors said they were confident the facility would allow the government to smooth out its rapidly rising bond issuance needs, rather than become an ever-growing source of finance. 

“We see this step as more sensational at a headline level than any significant step into the sort of monetary financing that invites comparisons to Zimbabwe,” said Andrew Mulliner, a bond portfolio manager at Janus Henderson.

“Trust is key and so far investor faith in the institutional integrity of the system remains intact. As bond investors, any move to a more permanent form of direct financing of the government would be a greater concern. This move from the Bank of England is not that,” he said.

The BoE had stepped up its involvement in bond markets since the onset of the coronavirus crisis, ensuring the government can fund itself cheaply. The central bank announced a £200bn bond-buying programme last month, helping to end a brief period of extreme stress in the gilt market.

Mr Dowding said the BoE’s actions had already blurred the lines. “In the long term I think they will be monetising some of this debt, and at some point in the future you will see inflation as a result,” he said. “But that’s unlikely to be the case in the near term while we are still dealing with the full extent of this crisis.”

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