As a corporate bond fund manager, the most interesting aspect of Mervyn King's speech was the reference to the Bank of England's plan to start making official purchases of high quality assets - including corporate bonds. This is part of a broader set of Treasury proposals to support the banking system that include a scheme to insure banks against further losses on their toxic assets.

Mr. King recognises that, in their desire to conserve capital, banks have substantially scaled back their market-making activity in corporate bond markets. A large part of the 5% plus spread of corporate bond yield over gilts is due to the reduction in liquidity that has resulted from such inactivity. This has made it both more difficult and more expensive for companies to raise finance via the bond market. The Bank hopes that buying up corporate bonds in the market will improve liquidity, reduce credit spreads and ease the refinancing worries faced by many companies.

The problem is that these good intentions have been overwhelmed by greater concern over the banking industry. The government's conversion of their holding of Royal Bank of Scotland preference shares into equity has undermined confidence in other banks' preference shares and deeply subordinated debt.

This is because previously, in the case of RBS, other preference share holders could take comfort from the knowledge that the government also wanted a dividend payment on their preference shares. There was therefore less likelihood that RBS would renege on payments that ranked ahead of / or equal to those due to the government. That is no longer the case, and this factor has rather clumsily undermined the value of all deeply subordinated bank debt, heightened the perceived risk in the banking system and caused the prospect of nationalisation to loom larger. 

Nor has it helped that the Bank's plan to buy corporate bonds is extremely thin on detail. All we know is that, from 2nd February, the Treasury will authorise purchases of up to £50bn of high quality private sector assets, including corporate bonds, financed by the issuance of Treasury bills.

The way has also been paved towards purchasing assets via the Bank printing money. This is typically done when normal interest rate policy proves insufficient in stimulating the economy and the Bank feels that such unconventional measures are necessary to offset the risk of deflation.

It is likely that the Bank's plan to buy corporate bonds will prove highly positive for this market. It is, after all, aiming to bring yield levels down towards gilts - which themselves are priced partially off base rates. The initial nonplussed response from the corporate bond market is understandable given the travails of the banking sector and the lack of detail within the plan. I expect fuller details by the end of the month. These should give greater clarity on how the Bank proposes to utilise its potentially large spending power in the market.

NOTE
Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM) are both authorised and regulated by the Financial Services Authority and their registered address is 1 Grosvenor Place London SW1X 7JJ. They are both subsidiaries of Jupiter Investment Management Group Limited and the group is collectively known as "Jupiter". The above commentary represents the views of the Fund Manager at the time of preparation and may be subject to change and this is particularly likely during periods of rapidly changing market circumstances. Their views are not necessarily those of Jupiter and should not be interpreted as investment advice. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.