BNY Mellon

BOE: Avoiding UK Mortgage Mayhem

The Bank of England went to great lengths Wednesday to stress that its intervention in Gilt markets is purely a financial-stability-related operation. The time-limited and targeted nature of the purchases is clearly different from the operational parameters of quantitative easing or yield curve control. Coupled with the fact that it was the Financial Policy Committee (FPC) which initiated the process that led to the purchase programme, the BoE will likely attempt to reassure markets that this is not a reversal of its willingness to tighten policy.

For now, markets are unlikely to see things that way – a reversal of quantitative tightening and short-term expansion of the BoE’s balance sheet may weigh on sterling. We think there is every chance that the Gilt purchase programme will be extended if fixed income volatility remains high. Market participants have long since abandoned efforts to push back against largescale asset purchases in government bond markets. The divergence in UK financial conditions against those in the US in particular means that the collapse in the relationship between front-end rate spreads and GBPUSD appears set to continue.

Media reports Wednesday suggested that the Bank of England acted due to concerns that the recent selloff in Gilts would leave many liability-driven investment (LDI) managers facing margin calls and lead to more forced sales of UK government paper; we expect the FPC to address the reasoning behind its decision in due course. We concur with the view that further volatility in the Gilt market would have led to sustained dysfunction in sterling fixed income markets, leading to material damage to the real economy.

Sterling weakness is one tangible manifestation of the uncertainty, but we believe the FPC and MPC would have been equally concerned about the state of the mortgage market. By Tuesday morning, the number of mortgage products available had shrunk by a third from the previous Friday before the budget was announced; originators were simply unable to adequately price their products. At the pace products were being withdrawn, the UK real estate market was staring at a sudden stop that would have devastating consequences for the economy.

As of Tuesday afternoon, products were still being withdrawn so this risk has not gone away. In the UK, an agreed mortgage offer is normally valid for between three to six months. However, with the prospect of very aggressive BoE rate hikes well within that time frame hanging over markets, providers simply had no visibility over their pricing or valuation accuracy and decided to pause offerings altogether.

We doubt that the BoE’s actions Wednesday will be enough to calm the market. We also expect market pressure to force the Treasury to bring forward the full fiscal plan for the budget and associated independent forecasts by the Office for Budget Responsibility (OBR). Once clarity is established and the BoE’s interest-rate curve has adequately repriced, mortgage products should be brought back online. Until then, the BoE will need to engage in quantitative operations to limit interest-rate volatility. We would also not rule out specific funding measures to support the mortgage market.