The Bank of England will buy bonds from the Government as an emergency measure
(Picture: Daniel Leal/AFP via Getty Images)The Bank of England has launched an emergency UK government bond-buying programme following the fallout of Chancellor Kwasi Kwarteng’s mini-budget.
As the pound fell to a record low against the dollar, lenders temporarily withdrew their mortgage products and economists warned that UK interest rates could reach six per cent.
However, the Bank of England’s new emergency measure aims to prevent the Government’s own borrowing costs from spiralling out of control.
The bank said: “Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability.
“In line with its financial-stability objective, the Bank of England stands ready to restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses.”
But what is a government bond and how does the BoE’s emergency programme work?
What is a government bond?
A UK government bond, also known as a gilt, is in effect a loan to the Government, but it can also be traded between investors on financial markets as listed assets.
During the time an investor owns the gilt, they will receive income from it every year in the same way that someone will receive interest on a loan.
Gilts are held by a range of institutions from pension funds to insurance companies, to help them fund their obligations, making them an important part of the financial system.
Gilts mature over different time periods and, when they do, the Government pays back the value of the original investment. Typically, longer durations pay higher yields and bonds backed by nations are usually less risky for investors than shares in companies.
Government bonds are used in the UK to cover a shortfall between income from taxes and public spending.
How does the Bank of England’s emergency measure work?
The Bank of England will launch a temporary UK government bond-buying programme.
It will purchase long-dated UK government bonds from September 28 until October 14.
The bank will buy the bonds at a high rate to offset the decline in government income from the Government’s newly announced tax-cut policy.
This means that the Bank of England is essentially acting as a backstop for government borrowing, preventing gilt yields from spiking too high.
The Bank of England explained that: "The purpose of these purchases will be to restore orderly market conditions. The purchases will be carried out on whatever scale is necessary to effect this outcome.”
