Bonds, Bank of England

Now we know who the Prime Minister of the UK is , we might ask - will Starmer be Trussed ?

Pension problems are being highlighted in the UK but the issue could easily spread across the world.  One main reason is because of the Pension managers have used bonds to fund the pensions.  So what is a bond? 

Treasury bonds (gilts)

Bond example

I lend the UK Government £1000 for 5years at 5% interest.    At the end of the 5years I will get all of my money back plus the interest.  I  feel this is safe because I trust that the UK Government will pay me back.  Bonds can be thought of as a sort of I.O.U , or a Government mini mortgage.   Now, in the jargon we have:

• Bond - a piece of paper issued by the Government which contains the details of a loan from eg the bank of England,  to the Government. But in the jargon, we say that the Government is selling or issuing a Bond. 
• Issue price - price at which the issuer originally sells the bond (£1000 in this example)
• Face value - amount the bond will be worth at maturity (£1000). aka "par" value. 
• Coupon - the interest that the issuer will pay on a particular date (in this case £50 a year for 5years total £250).  The Coupon reflects the rate of interest at the time of issue in the Country it was issued. Coupon rate is fixed. 
• Yield - the total return including coupon, and any tax or losses.  yield is variable and changes according to market price. 
• Maturity date -  the date on which the issuer will pay the face value

Coupon relates to Official interest rates

If interest rates drop (as they have in recent years due to eg Covid) to say 2.5%, then newly issued bonds would get £25 per year  ie only half of the 5% we talked about above.  So the price of our  example bond in the market place will rise from £1000 to £2000 (because the market has changed and you need twice as many new bonds to achieve the same interest income each year). 

So this is an INVERSE relationship which means that  as the rate of interest goes down, the price of bonds goes up because they have a fixed coupon attached to them. 

If interest rates rise to say 10%, and £1000 bonds are now paying £100 interest per year, then my original bond which is only paying £50 per year would only be worth £500 in the market place (because I need twice as many of them to achieve the yearly income). 

Although the following Youtube video has a title about Russia, it contains a good visual explanation about what's happening to pensions. 

Joe Blogs explains pensions funds using bonds as funding .

Bonds, Bank of England & Liz Truss

Youtube video 5th July 2024 from Southbank Investment Research with Nick Hubble ( editor of Fleet Street Letter financial magazine).  This explains the Bank of England and the Liz Truss Government collapse. 

 

Nick Hubble says that Andrew Bailey (Governor of the Bank of England) is really a kind of shadow Prime Minister.   He mentions former PM Liz Truss saying that she was effectively fired from her job by Bailey at the BoE.  

What is the Bank of England?

On it's website, the BoE says:    "We are the UK’s central bank and are owned by the UK government. But we have specific statutory responsibilities for setting policy – for interest rates, for financial stability, and for the regulation of banks and insurance companies. And we carry those out, for the good of the people of the United Kingdom, within a framework set by Government but free from day-to-day political influence."

Did  Bailey at the BoE fire Liz Truss?

The Bank of England controls the Bond market which in turn controls the Government.   The Government has to pay it's bills (like we pay our mortgages), and so when the BoE puts interest rates up on the national debt, that means the Government can spend less on other things.   The BoE also buys and sells Bonds  as a way of managing inflation.  The BoE can decide whether to support Government borrowing by buying bonds, or undermine that borrowing by selling bonds. 

Liz Truss.  On the day before Liz Truss mini budget, the BoE held it's monetary policy committee meeting and decided to announce that it would begin selling £80 billion worth of bonds. It also raised interest rate from 1.75% to 2.25% (50 basis points). This was the highest rate rise since 2008 despite declining Gross Domestic product (GDP).  This change meant that the BoE would go from buying Gov Bonds in support of Gov spending during the pandemic , to selling Gov Bonds to reduce inflation.   This left the Truss Government having to try to fund itself whilst at the same time it's own BoE would be undermining those efforts by selling their own bonds too. The BoE announced the bond sale the day before they knew that the mini budget would be released. It did not intervene to prevent a bond market crash for a full 5 days. Not financing the Government, or even the threat of not doing so, amounts to an act of neglect or sabotage and the The Liz Truss Government collapsed. 

Governments and Central banks across the world saw what happened and took note.  A left wing central bank can chop the legs off a right wing Government (or right / left as the case may be).