The Bank of England (BoE) has opted to intervene in bond markets, saying it would start buying long-dated government bonds at "whatever scale is necessary" in a bid to "restore orderly market conditions".
The move comes after the cost of UK government borrowing spiked dramatically in recent days, surpassing rates paid by Italy and Greece.
To finance higher borrowing to pay for the £45bn tax cuts announced by chancellor Kwasi Kwarteng last week, an extra £72.4bn in debt sales are now planned for the current financial year alone.
So how does this affect households and markets and what action has the BoE taken to help?
Watch: Markets in the green following Bank of England’s bond purchasing plan
Bonds, gilts and yields? What do these terms mean and why do they matter?
Bonds are debt instruments and represent loans made by investors to a bond issuer.
Governments (at all levels), corporations and other organisations commonly use bonds when they need to raise funds by borrowing the money.
UK government bonds are also commonly referred to as gilts.
Bond yields represent the amount of money an investor receives for owning the debt as a percentage of its current price.
Rising bond yields suggest a lack of willingness among investors to own the debt as buyers demand a lower price to buy them.
The bond market is the world's biggest securities market, worth over $100tn (£93tn).
The turmoil in the market following the sell-off in the UK has drawn comparisons to an emerging market economy such as Mexico rather than the world’s fifth largest.
Kwarteng's mini-budget is viewed as the main reason why this has happened, and his unfunded tax-cutting plan has also triggered a drop in the pound amid fears over the state of the economy and public finances.
What action has the Bank of England taken?
The Bank of England has launched a bond-buying programme to buy as many long-dated government bonds as needed to stem the market mayhem.
The initial gilt purchases will be worth up to £5bn per auction, with the first to be carried out between 3pm and 3.30pm on Wednesday 28 September.
It was originally planned for mid September but was pushed back due to Queen Elizabeth's death.
The Bank said that it is ready to purchase conventional gilts with a residual maturity of more than 20 years in the secondary market, adding that the parameters of the scheme will be kept under review.
Why is it doing that?
The BoE aims to tackle the consequences of rising bond yields in several markets including pension funds and mortgages.
As a result it is buying UK government bonds to try to halt a dramatic sell-off, warning of a "material risk to UK financial stability" in the wake of the fiscal plan.
The Bank described the purchases of the UK government debt as "temporary and targeted" but said they would take place at an "urgent pace" until 14 October.
However analysts have cast doubt on whether the Bank's move will be enough to calm sceptics.
Russ Mould, investment director at AJ Bell said the BoE's U-turn may not be enough to put "bond vigilantes" — investors who sell off bonds in protest against fiscal policy — "firmly back in their basket".
"The Bank is still going to try and navigate inflation on one hand and the threat of recession on the other, while at the same time trying to keep an eye on sterling and market volatility," he said. "It’s not a very easy balancing act."
"Having probably given the market a lesser-rate hike than it expected last week and to confirm that it was committed to quantitative tightening, to then have to come back to quantitative easing a week later … it’s not going to convince the sceptics."
Watch: Bank of England bids to calm markets, but pound is hit again
How it is connected to the pound?
There has been volatility in markets since the pound crashed to an all-time low earlier this week.
The pound fell 1.5% against the dollar and more than 1% against the euro following the BoE's announcement.
Sterling's fall has caused a record stampede out of UK government bonds, with investors anticipating it will add to the government’s already sizeable budget deficit.
The wild price moves on Wednesday forced the BoE to step in and try to bring down borrowing costs.
UK bonds surged following the announcement. The UK 30-year yield hit its highest since 1998.
Yields on the 10-year UK bonds, which jumped as high as 4.56% — the highest since the financial crash — and more than triple the 1.3% rate at the start of 2022.
How are bond markets linked to mortgage lending?
Bond prices have an inverse relationship with mortgage rates. As bond prices go up, mortgage interest rates go down and vice versa.
Mortgage lenders (banks) use swap rates to mitigate interest rate risk in fixed-rate home loans.
So when they decide to issue fixed-rate home loans, they usually lock in the current interest rate by entering into swap contracts.
Swap rates are an agreement between two parties where they agree to exchange one stream of future interest payments for another, based on a specified principal amount.
Mortgage prices look set to rise further, costing borrowers hundreds of pounds extra every month.
The yield on two-year interest rate swaps, which lenders typically use to price mortgage products, hit almost 6% this week — its highest level since 2008.
Meanwhile the two-year mortgage costs are still lagging behind at between 3% and 5%.
The dramatic rise in swaps rates suggests lenders will have to ramp up the cost of new mortgages in the coming weeks.
Pension funds and how they are linked to bonds
The Bank of England was forced to step in following warnings of an imminent crisis in the sector amid fears of mass insolvencies of pension funds.
Pension schemes depend on the gilts market for their funding and for the structure of their investments.
The Bank's decision to purchase gilts of a 20- to 30-year duration affects traditional pension funds where a retiree is guaranteed a certain payout at their retirement based on their final salary when they retire.
Many of these funds use long-dated gilts as part of their investments. However over the last few days a lot of the investment funds have been asking pension funds to put up cash, or post more collateral.
The Times reported that these cash calls have been running into tens of billions of pounds since the start of the week because of this spike in long-dated gilt yields
The Pensions Regulator has welcomed the central bank's intervention in bond markets and said it's monitoring the situation closely.
"We are monitoring the situation in the financial markets closely to assess the impact on DB [defined benefit] pension scheme funding," it said.
"We welcome steps announced by the Bank of England to restore orderly conditions through temporary purchases of long-dated UK government bonds."