The Bank of England’s (BoE) new corporate bond purchase scheme came as a positive surprise to the sterling bond market. Within the OMGI Fixed Income team we took the view, prior to the BoE’s announcement on 4 August, that further UK government bond purchases were highly likely, and that this in itself would have a positive effect on long-dated corporate bonds; yet we were by no means certain that corporate bonds themselves would also be purchased by the central bank.
It is the second time the BoE has purchased corporate bonds – the first time was in 2009, when it purchased some £3 billion in order to restart a frozen market. This time around the central bank has greater ambitions: it will purchase £10 billion of investment grade non-financial sterling corporate bonds over the eighteen months from mid-September 2016. This is a highly significant part of the BoE’s total package, in addition to the cut in interest rates to 0.25%, and its plans to buy £60 billion of UK government bonds.
Why do it?
Credit easing was originally introduced in March 2009, as a remedy for crisis. Yet there is currently no crisis in the corporate bond market. Credit spreads (the difference between yields on corporate and government debt) are relatively low in comparison with the extremely wide levels seen in 2009.
A clue to the BoE’s thinking comes in the language it uses in its eligibility criterion for the corporate bonds to be included in its purchasing program. To be eligible for purchase, the bond’s issuer must make a ‘material contribution to economic activity in the United Kingdom’. Hence, the BoE hopes that reducing borrowing costs for large companies will help money circulate in the real economy. It wants to ensure that its stimulus goes where it can possibly do most good.
It is also the next blast in the ongoing global funding war. Japan and Europe are both currently purchasing corporate bonds; were it not to follow suit, the BoE would risk leaving British companies at a comparative disadvantage in terms of funding costs. As the BoE pointed out, the program will stimulate issuance in sterling corporate bond markets.
How will it work in practice?
The BoE’s corporate bond purchasing programme has and will further lower borrowing costs for companies and should therefore encourage them to invest. This will, in my view, have a positive effect on jobs and economic growth in the UK, and counter some of the depressive effect of the Brexit vote, after which some companies may be tempted to delay investment decisions until details of the UK’s future relationship with the EU becomes clearer. In addition, the Bank of England’s actions will encourage more investment in sterling corporate bonds. New investors, both domestic and international, now feel that the sterling corporate bond market is underpinned by a long-term buyer.
Lower interest rates, and the possibility of negative interest rates on corporate bank accounts, will also deter companies from holding too much cash and should further encourage them to use cash balances in a more productive manner.
The announcement of the program has already had the effect of stimulating new issuance of corporate debt (i.e. companies are borrowing more). There has been over £2 billion of new investment grade corporate issuance in the week since the announcement, a significant part of the £8.9 billion year-to-date balance.
What will be the effect on the corporate bond market?
Corporate bonds have already strengthened this year. In my view the rally in corporate bonds has further to go, against a backdrop of the BoE’s purchase program and the much larger program being run by the European Central Bank. Indeed, credit spreads are still not back down at 2014 levels, let alone the lower levels reached before the 2008 financial crisis.
Our conservative positioning, with a bias towards high-quality, longer-dated sterling denominated corporate investment grade bonds, means we have been a beneficiary of an environment in which the BoE is purchasing both gilts and corporate bonds.
In short, the BoE’s corporate bond purchasing scheme is beyond doubt a positive for the economy – it improves access to funding for some of the country’s largest employers, and this will have a positive knock-on effect on jobs and the economy. It ensures UK companies are not at a disadvantage to international peers. It is obviously positive for the corporate bond market too – it increases liquidity, stimulates issuance and brings in additional investors to the country’s bond market. It was a bold move by the BoE and could prove to be the essential tool in order to combat the post-Brexit blues.