Providing Bank of England loans to pension funds worth just 0.23% of GDP could have similar market impacts to the actual asset purchase programme of 0.9% of GDP that took place in autumn 2022, economists say in a new blog post.

The ‘Bank Underground’ blog represents the views of the authors, rather than the Bank of England, which says the blog is for its staff members to share views about policy. 

In a post published on Thursday, research economists Nicolò Bandera and Jacob Stevens explore the monetary policy and inflation impact of the Bank’s intervention during the 2022 gilts crisis, and find that despite the loosening effect central bank gilts purchases normally have, the Bank’s tightening monetary policy continued to work at the time.

This was possible because the market stability action was only temporary. Between late September and mid-October, the central bank stepped in as a buyer of last resort for £19.3bn worth of gilts, to shore up prices and avoid the problem spilling over into other markets. Had the asset purchases been more permanent, it would have run counter to the Bank’s monetary policy, they note. 

 
As part of their modelling, the economists discover what would have happened had there been a ‘repo loan’ to pension funds by the Bank of England, or if there had been requirements for a higher liquidity buffer going into the crisis. 

They suggest that offering loans to pension funds would have worked to cut the vicious cycle that ensued when LDI managers sold gilts to keep leverage to contractual levels. 

“Providing liquidity to pension funds – on condition they inject it into the LDIs as equity – could be effective at resolving the crisis,” they write, suggesting this would have reduced the size of the Bank intervention: “In our setup, loans to pension funds worth 0.23% of GDP have similar market impacts as the actual asset purchase programme worth 0.9% of GDP.”

They also remark that providing loans to LDI funds that are looking to deleverage would not have had the same effect since “a central bank’s repo loan would only replace one kind of leverage with another”. 

In October 2022, the Bank of England offered a ‘Temporary Expanded Collateral Repo Facility’ which accepted investment-grade corporate bonds as collateral to banks dealing with LDI funds. 

Modelling how larger liquidity buffers would have cushioned pension funds, the pair estimate that requiring pension funds to hold liquid assets worth 2.75% of LDI assets would offset half of the ‘LDI effect’ on gilts’ prices. 

This on its own would therefore not have resolved the market dysfunction, but the authors argue that “the problem would have been partly alleviated and any asset purchases or repo would have been significantly smaller”. 

They admit that holding a larger liquidity buffer also means pension funds having to accept lower returns during normal times. 

After the 2022 crisis, the Pensions Regulator imposed requirements for higher buffer levels than most funds previously had. However, the rise in gilt yields that precipitated the LDI reaction ultimately helped most pension funds reach full funding, meaning the need for leverage today is lower than it was two years ago. 

The episode raised questions about how well regulators understood how different parts of the financial system interact during a crisis. The Bank of England recently published its conclusions from a system-wide exploratory scenario undertaken after the crisis, warning that there are still vulnerabilities in the system.