A British government committee will raise concerns with the Bank of England on Monday that declining liquidity in bond markets could threaten the stability of the gilt market. Lawmaker Andrew Tyrie, chairman of the Treasury Committee, said some of the regulatory and monetary actions taken in response to the financial crisis were restricting liquidity.
"This is of paramount importance, given both the challenge of financing the government deficit and the task of safeguarding stability," he said on Sunday.
He said a combination of quantitative easing divestments, rising interest rates and new regulation may leave the British economy vulnerable to a vicious circle of declining liquidity in the event of a shock to bond markets, possibly triggered by even a relatively modest rise in interest rates.
"In other words, in current conditions, regulatory action could inadvertently compromise, not bolster, financial stability," he said.
Worries about liquidity have already been voiced by Robert Stheeman, chief executive of the UK Debt Management Office, the government body that facilitates debt sales.
He said in July that a lack of liquidity, caused by banks reducing allocations for trading accounts because of new regulations, was the organisation's biggest challenge.
"While the gilt market has been protected to a certain extent, liquidity is arguably not as good as it once was," he said.
Tyrie will ask the Bank of England in a letter to detail its views, in particular on the impact that an unwinding of quantitative easing measures could have on the gilt market and financial stability.