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Why did the BoE have to intervene in the bond market?

Following on from Kwarteng’s mini budget, the announced tax cuts would be funded via borrowing. Investors were concerned by the approach to fiscal policy and triggered a sell-off of assets greatly affecting the market.

With rising interest rates, gilt yields also increase due to increased government borrowing. Gilt yields and prices have an inverse relationship. This means that bond prices decreased which means that demand for them was also decreasing.

If a bond is placed up for collateral for a hedging position, and the value of the bond continues to fall, they are likely to sell the bond for cash to prevent further decreases in the value of collateral. This will avoid the requirement to provide more collateral to meet the minimum capital requirement for the derivative positions to remain valid.

Given the demand for bonds was decreasing and one of the largest holders of bonds (pension funds) wanted to sell, there was a supply-demand issue. To prevent this spiralling out of control and pension funds not having enough cash to meet collateral requirements, the BoE had to intervene and purchase the bonds. This provided liquidity into the market to fix the supply-demand issue.



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