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We have a quick question here from Sakeem, asking us what exactly is meant by BOE buybacks? It’s a news item that he normally sees popping up in the terminal and wants to know what it is.
So looking at the terminal, we can see this announcement in the terminal. That is what Sakeem is referring to. It’s saying that we had a BOE, they had a 1.5 billion buyback of seven to 20 year guilds or bonds and furthermore, we can see that it had a offer to cover ratio of 3.17 times.
So this means that they were three times more guilds on offer for the bank to buy than the bank was willing to buy from the market. Now, the success of a buyback is usually determined by the offer to cover ratio. So it’s definitely something to watch in terms of the cover ratio.
Now, why are the BOE buying back these bonds? Well the answer of that is of course, QE. The bank has opted to buy short, medium and long-term maturity bonds, or in this case, guilds as part of the asset purchase facility.
Now they buy bonds from the open market, that is from institutions or pension funds or commercial banks do accomplish two things. Firstly, by buying bonds, they are trying to pump liquidity into the system and keeping rates low because when they buy bonds in the open market, the BOE is keeping bond prices in demand, which in turn of course keeps the yields low. Which means the overall borrowing cost are kept low as well across the curve, which is good for economic growth or theoretically good for economic growth at least.
Now the second reason why they are buying bonds is to keep up with the government’s debt. So the government needs to spend money and they get that money by issuing new debt or bonds. Now, in this case, guilds. Now if the government issues tons and tons of bonds without the BOE buying them, that would create a loss of demand for bonds, which will push their yields much higher. Which means borrowing costs will rise and not only for the government that needs to pay back the higher yields, of course, but also for the broader economy, it will also mean higher borrowing costs.
So to try and keep that from happening, the BOE will try and buy all the bonds that the government plans to issue. And that way they keep yields from rising and obviously stabilize the bond market. So on a regular day-to-day basis, these operations are not really going to be all that market moving because the market already knows what the size and the scope of the banks’ asset purchase facilities are.
But when it does get more interesting, of course, is when we have a negative offer to cover ratio. So that means investors or sellers are not really willing to sell the guilds to the BOE.
So when that happens, it should create some upside pressure in the guilds, so in the bond prices, as it would mean that the BOE would need to offer a higher price for the guilds to get people to let go of them.
Now, when that happens, of course, it means lower yields and even though lower yields is what the bank wants, in times like this however, it might also lead to the market to start to think that the asset purchase program is running into challenges. Which will obviously pose a problem for stimulus hopes and that could put more pressure on the treasury to spend more, and of course, we have a vicious and negative cycle.
So that might lead to the BOE requiring to look at other easing or stimulus measures or might lead to the market thinking that the BOE would need to look to other easing stimulus measures maybe negative interest rates, et cetera, which could of course be pound negative from an additional stimulus point of view, but it might also be positive from a less asset purchases point of view.
So it is definitely something to keep in mind but only when we have a major disappointment in terms of the offer to cover ratio. Apart from that, it’s normally not going to be a real big market mover as the market already knows that the BOE will buy these bonds in various maturities, for specific amounts.
So I hope that helps Sakeem. Any other questions, just let us know.