2022 has been an extraordinary year for financial markets. It's somewhat of a reversal of what we've experienced for much of the last decade as the real economy is doing much better than the markets. This has included such unimaginable developments as inflation hitting its highest level in decades, crashes and liquidation for many speculative assets, and a job market that won't crack despite the Federal Reserve's increasingly aggressive policy.
We can add to this list the Bank of England intervening in the bond market, following steep losses due to incoming Prime Minister Truss' economic plan that is going to increase deficits despite the central bank hiking rates and sky-high inflation. Adding to the pain was the sharp drop in the British Pound which also makes U.K. bonds less attractive to foreign buyers.
The major impetus for the intervention was that many pension funds are large owners of U.K. government bonds. Steep losses in the value of these assets could have led to nasty, spillover effects that could destabilize markets and lead to even more selling.
As a result, the Bank of England is embarking on a 2-week purchase program for bonds. It will also delay the winding down of its balance sheet. Of course, this is essentially a version of quantitative easing (QE) which is at odds with its goal of curbing inflation. The central bank said the intervention was necessary to prevent credit from not flowing in the real economy, and it would continue on "whatever scale is necessary".
For many market participants, the main question is whether this confluence of events in England was an anomaly or is it a preview of what European economies are going to face in the coming months because they are battling with the same issues of energy security and accelerating inflation.
The move is expected to allow pension funds to rebalance their holdings and not be forced to liquidate at depressed prices. The central bank stressed that this is a temporary decision, and it still sees total sales of £80 billion in bonds this year. However, many economists are skeptical that this is workable especially if the deficit is exploding as higher rates will only add to funding pressure.