Two of the world's most senior central bankers have issued a warning that governments may believe they have years to repair their finances, but bond markets can decide otherwise in an afternoon. Pablo Hernández de Cos, General Manager of the Bank for International Settlements, cautioned last week that government bond liquidity can dry up suddenly, reducing fiscal space.
Bank of England Governor Andrew Bailey reinforced this message three days later, stating that higher public debt and a changing investor base have made sovereign bond markets increasingly vulnerable to sudden reversals. The risk is that investors demand sharply higher returns to finance government debt, undermining fiscal plans and absorbing more government revenue.
The UK experienced these consequences during the 2022 gilt crisis, when leveraged pension fund strategies were forced to sell assets. The Bank of England intervened by temporarily purchasing government bonds to prevent disorderly trading. This intervention bought time for pension funds to reduce leverage while the political system began correcting the fiscal course, with tax measures reversed, the Chancellor replaced, and the Prime Minister resigning.
Central bankers face a dilemma: while emergency interventions can address technical breakdowns, they cannot indefinitely suppress the cost of unsustainable borrowing without compromising credibility and inflation objectives. Long-term financial stability ultimately depends on governments taking decisive political action.