Bank of England’s new emergency measure aims to keep government borrowing costs from spiraling out of control
The Bank of England has launched an emergency UK government bond-buying programme, following the outcome of Chancellor Quasi Quarteng’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 as high as six per cent.
However, the Bank of England’s new emergency measure is aimed at preventing the government’s own borrowing costs from spiraling out of control.
The bank said: “Continuation or worsening of this market, there will be a material risk to the financial stability of the UK.
“In line with its financial-stability objective, the Bank of England stands ready to restore market functioning and mitigate any risk in the transition to credit conditions for UK homes and businesses.”
But what is a government bond and how does the BoE’s emergency program work?
What is a government bond?
A UK government bond, also known as a gilt, is actually a loan to the government, but it can also be traded as a listed asset among investors in the financial markets.
During the time during which an investor owns the gilt, he or she will receive income every year in the same way that someone would receive interest on the loan.
Gilts are organized by many institutions, from pension funds to insurance companies, to help them meet their obligations, making them an important part of the financial system.
Gilts mature in different time periods and when they do, the government pays the value of the original investment. Typically, higher returns pay out over the long term and nation-backed bonds are generally less risky to investors than stocks in companies.
In the UK government bonds are used to bridge the gap between taxes and public spending income.
How does the Bank of England emergency measure work?
The Bank of England will launch a temporary UK government bond-buying programme.
It will buy long-lasting UK government bonds from 28 September to 14 October.
The bank will buy bonds at a higher rate to compensate for the fall in government income from the government’s newly announced tax-cutting policy.
This means that the Bank of England is essentially acting as a backstop for government borrowing, preventing the gilt yield from rising too high.
The Bank of England explained that: “The purpose of these purchases will be to restore orderly conditions to the market. Purchases will be made at whatever scale is necessary to effect this outcome.”
Credit: www.standard.co.uk /