Treasury select committee chairman Andrew Tyrie has written to the Bank of England’s governor Mark Carney asking for the Financial Policy Committee’s view on the risk of declining liquidity in the bond market.
Mr Tyrie stated some of the regulatory and monetary actions and decisions taken in response to the financial crisis are now restricting liquidity in the gilt market, something he said was of “paramount importance”, given both the challenge of financing the government deficit and safeguarding financial stability.
“A combination of QE divestments, rising interest rates, and new regulation may leave the UK economy – in the event of a shock to bond markets, possibly triggered by even a relatively modest rise in interest rates – vulnerable to a vicious circle of declining liquidity and financial distress.
“In other words, in current conditions, regulatory action could inadvertently compromise, not bolster, financial stability.”
Mr Tyrie argued parliament needs to be confident that the Bank of England, the Debt Management Office and HM Treasury are taking appropriate steps to limit these risks.
“Among other things, it is important that respective responsibility for liquidity risk has been clearly identified,” he added.
Earlier this month, Morningstar data revealed that investors in Europe and the UK had started pulling their money out of fixed income funds at historically high rates, with an outflow of €16.3bn (£11.6bn) in September, as Chinese economic problems and uncertainty over interest rate policy in the US, UK and Europe, conspired against the asset class.
The Bank of England and US Federal Reserve appear to have diverging monetary policies, with Mr Carney suggesting that any UK interest rate rise would be pushed back after a downbeat inflation report in November.
However, this cautiousness contrasts with the Fed hinting on October 28 that a December rate rise was still on the table, stating that global growth risks had receded since September.
Kames Capital’s Adrian Hull pointed out that the first rate hikes by central banks will not in fact cause retail investors to rush for the exit in bonds, as the certainty may actually improve trading conditions.
peter.walker@ft.com
