Liz Truss has called for an investigation into the Bank of England (BoE) after a report by its own analysts found that the majority of the bond market crash under her short tenure was caused by dangerous practices in the pensions industry.
The former prime minister said the report meant “the Bank of England itself acknowledge[d] the yield spike was not my government’s fault”.
Ms Truss was in Downing Street for just 49 days before turmoil following her heavy-borrowing mini-Budget forced her out of office.
A working paper, written by five members of Bank staff and published in May, studied risks which built up in the long period of very low interest rates following the financial crisis, as funds hedged against the threats to their solvency.
They found that dangers mounted as institutions which were “not particularly sophisticated at managing their liquidity risk” set up positions which were vulnerable to sharp rises in interest rates. The analysts call this Lash risk – short for liquidity after solvency hedging. This occurred “well in advance of the onset of the crisis and before the election of Liz Truss as prime minister”, according to the report.
The Bank of England began raising rates in December 2021 and market rates jumped again with the mini-Budget in September 2022.
As a result, funds were forced to sell off bonds to free up cash, worsening the jump in government borrowing costs and setting off a vicious spiral which was only defused when the Bank launched an emergency program to buy bonds and stop prices plunging.
“The abrupt change in the fiscal stance initiated a sharp downward adjustment in government bond prices, which was amplified by the vulnerabilities – Lash risk – in the pension fund and LDI [liability-driven investment] sector,” the working paper said.
The analysts concluded that 0.66pc – almost two thirds – of the 1.03pc jump in 30-year borrowing costs was caused by “Lash-induced trading”.
Ms Truss said it showed questions needed to be asked at the BoE.
“While my political opponents continue to parrot lazy, meaningless and false narratives about crashing the economy, virtually no one is asking the pertinent questions of the Bank of England about the impact of its decisions and regulatory failures,” she said.
“The new Chancellor ought to be ordering an urgent investigation into what her former colleagues at the Bank of England were up to prior to the LDI crisis and holding them to account for their actions.”
A separate report by Bank analysts, published on the Bank Underground site last month, found that the mini-Budget was responsible for around half of the jump in borrowing costs. Although Ms Truss’s plans set off the crisis, the “fire sale” of pension fund assets made the market turmoil twice as severe, Bank Underground reported.
The Bank of England declined to comment.