London Stock Exchange
The BOE confirmed the end of its bond-buying operations on Monday, and highlighted that its temporary expanded collateral repo facility would remain available until November 10. Image Credit: Bloomberg

London: UK government bonds surged and the pound rallied as investors wagered the government will further depart from the expansive fiscal strategy that plunged markets into turmoil.

The yield on 10-year gilts fell as much as 36 basis points to 3.98 per cent while the pound traded 0.9 per cent higher at $1.1273 as of 10:45 am in London. Newly-appointed Chancellor of the Exchequer Jeremy Hunt is set to give a statement later Monday on measures to support fiscal sustainability, in advance of the medium-term fiscal plan slated for the end of the month.

The negative market reaction to the initial mini-budget proposals has already forced Prime Minister Liz Truss to backtrack on a series of tax-cut pledges and fire her first chancellor Kwasi Kwarteng. Still, the government faces additional pressure to restore investor confidence in public finances now that the Bank of England’s emergency bond-buying operations, which acted as a backstop to the market, have ended.

“Hunt’s speech is a make-or-break event for sterling,” said Francesco Pesole, an analyst at ING. It coincides “with the first day of gilt trading without the support of the Bank of England’s temporary bond-buying scheme, which puts even further pressure on Hunt to deliver a credible plan to fix the UK’s troubled fiscal position.”

Traders also pared bets on BOE rate hikes, as a reduced stimulus package takes the pressure off the central bank to tighten more severely. Money market wagers show the rate peaking at 5.3 per cent in 2023, the lowest level since the announcement of the mini-budget on September 23. Two-year bond yields, the most sensitive to interest rates, dropped as much as 34 basis points to 3.58 per cent.

The BOE confirmed the end of its bond-buying operations on Monday, and highlighted that its temporary expanded collateral repo facility - aimed at enabling banks to help ease liquidity pressures on liability-driven investment funds - would remain available until November 10.

Monday’s moves continue the whipsawing price action that has seen 30-year government bond yields ricochet from as high as 5.14 per cent to as low as 3.62 per cent in the last three weeks. While yields have fallen, they are still elevated compared to where they were at the start of September at around 3 per cent.

Former Bank of England Deputy Governor Charlie Bean said on Sunday that it is “disingenuous” to blame the rise in gilt yields as a “global phenomenon” and that a quarter or a third of this year’s increase was UK-specific.

“We’ve moved from looking not too dissimilar from the US or Germany as a proposition to lend to, to looking more like they did in Greece,” Bean told “Sophy Ridge on Sunday” on Sky News.

It is still unclear to what extent LDI funds, which exacerbated the bond market sell-off after facing collateral calls, have been able to build up buffers to protect against further spikes in gilt yields. That could render them vulnerable if market sentiment swings the other way.

The pound outperformed other Group-of-10 peers. It was being supported by unwinds of downside options structures, a Europe-based trader said. European government bonds also rallied, with the yield on 10-year German bonds falling 11 basis points to 2.23 per cent.

“Its all about Hunt now. The measures in the mini-budget that he will reverse beyond the corporation tax announcement of Friday,” said Societe Generale SA strategist Kenneth Broux. “How much will be left in unfunded borrowing and how they plan to close that with spending cuts.”