Truss Demands BoE Probe as Report Shifts Blame for Bond Crisis

Liz Truss, the former British Prime Minister who served the shortest term in UK history, has called for an investigation into the Bank of England (BoE) following a report that shifts blame for the 2022 bond market crash. The report, authored by BoE analysts, suggests that dangerous practices in the pensions industry, rather than Truss's controversial mini-Budget, were primarily responsible for the financial turmoil.

The BoE working paper, published in May 2024, examined risks that accumulated during the extended period of low interest rates following the 2008 financial crisis. It identified a phenomenon called "Lash risk" (Liquidity After Solvency Hedging), which developed "well in advance of the crisis and before the election of Liz Truss as prime minister."

According to the report, funds that were "not particularly sophisticated at managing their liquidity risk" established positions vulnerable to sharp interest rate increases. The BoE began raising rates in December 2021, with market rates surging further after the September 2022 mini-Budget. This forced funds to sell bonds, exacerbating the rise in government borrowing costs and triggering a vicious cycle.

The analysts concluded that nearly two-thirds of the 1.03% jump in 30-year borrowing costs was caused by "Lash-induced trading." In response, Truss stated, "The Bank of England itself acknowledges the yield spike was not my government's fault."

"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."

Truss called on the new Chancellor to order 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."

It's worth noting that the Bank of England, founded in 1694, is the second-oldest central bank globally and has been setting interest rates independently since 1997. The UK pension industry, with assets exceeding £2 trillion, is one of the world's largest, and liability-driven investment (LDI) strategies gained popularity in the early 2000s.

A separate report published on the Bank Underground site in July 2024 found that while the mini-Budget was responsible for about half of the borrowing cost increase, the "fire sale" of pension fund assets doubled the severity of the market turmoil.

As this debate unfolds, it's crucial to remember that the Bank of England, under Governor Andrew Bailey since March 2020, plays a vital role in maintaining financial stability. The institution's decisions and actions continue to shape the UK's economic landscape, highlighting the complex interplay between fiscal policy, monetary policy, and financial market dynamics.