The Bank of England (BoE) tried to quell a storm in the British bond market, announcing on Wednesday that it will buy as much public debt as is needed to restore financial stability after the chaos caused by the fiscal policy of the new government.
Having failed to cool selling with verbal interventions in the previous two days, the Bank of England announced an emergency measure it said would prevent market turmoil from spreading across the country and hitting credit flows.
“If the dysfunction in this market were to continue or worsen, there would be a significant risk to the financial stability of the UK,” the Bank of England said. “This would lead to an unjustified tightening of financing conditions and a reduction in the flow of credit to the real economy.”
Sterling was down 0.7% at $1,065, after falling to a session low of $1.0618.
The Bank of England said it is sticking to its target of reducing its 838 billion pounds ($892 billion) of gilt holdings by 80 billion pounds over the next year, but that will postpone the start of sales – which were due to start next week – due to market conditions.
Earlier, the International Monetary Fund (IMF) and rating agency Moody’s had increased pressure on Britain to reverse its new strategy, laid out by new Finance Minister Kwasi Kwarteng on Friday, in a move that , according to him, would boost economic growth.
The rare intervention in a G7 country by the IMF, the world’s lender of last resort, underscored the seriousness of the situation facing Britain, with the value of the pound and British bonds plummeting since Friday.
The Bank of England had said on Monday it would not hesitate to raise interest rates and was watching markets “very closely”. Its chief economist, Huw Pill, said on Tuesday that the central bank was likely to carry out a “significant” rate hike at its next meeting in November.
Despite these comments, the market was still in full swing.
UK 30-year government bond yields topped 5% for the first time since 2002 on Wednesday as, following the BoE statement, 30-year yields fell more than 50 basis points on the day.
The latest crisis to hit the British state has been triggered by Kwarteng’s plans to implement deep tax cuts and deregulation to lift the economy out of a long period of stagnation, seen as a return to Thatcherite and Reaganist doctrines of from the 1980s.
With the cost of British borrowing rising, mortgage lenders withdrew hundreds of products and, according to anecdotal reports, people were trying to complete or change mortgage deals.
This would come as quite a shock in a country where rising house prices have for years created a sense of general wealth, and where home buyers have grown accustomed to more than a decade of rock-bottom interest rates. .
The IMF said the proposals, which took the pound to a record low of $1.0327 on Monday, would add to a credibility crisis, after the government cut taxes and increased borrowing just as the Bank of England raised rates. interest rates to deal with rising inflation.
“Given the elevated inflationary pressures in many countries, including the UK, we do not recommend large, untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work against monetary policy,” an IMF spokesperson said. .
Jim Reid, a research strategist at Deutsche Bank, described the “reprimand” as “pretty scathing”.
The IMF is of symbolic importance in British politics: its rescue in 1976, following a balance-of-payments crisis, forced massive spending cuts and has long been regarded as a humiliating low point in the modern economic history of the UK. country.
The British crisis is also being watched around the world, and Spain’s socialist economy minister, Nadia Calviño, has used it to attack her conservative opposition.
“We are all capable of seeing how it is leading the country not to adrift, but to disaster,” he said. “An irresponsible and destructive fiscal policy that dismantles the welfare state”.
In a blunt statement, Moody’s said large unfunded tax cuts were “credit negative” for Britain, with the risk of a structural rise in funding costs that could weaken the economy.
Kwarteng, an economic historian who was finance minister for two years, has responded to criticism by insisting that tax cuts for the wealthy, along with support for energy prices, are the only way to reignite the economic growth.
The IMF said its November 23 fiscal plan would provide an “early opportunity for the UK government to consider ways to provide more targeted support and to reassess fiscal measures, especially those that benefit high incomes.”
Britain’s Treasury Department said the November announcement would detail the government’s plans to reduce debt in the medium term.
“We are focused on growing the economy to raise everyone’s standard of living,” a spokesman said.
Facing mounting anxiety in the financial sector and among lawmakers from the ruling Conservative Party, Kwarteng has spoken with chiefs of the banking, insurance and finance sectors, and will meet more bank chiefs on Wednesday.
In his remarks on Tuesday, the Bank of England’s chief economist, Pill, said the financial market turmoil would have a major impact on the economy and would be taken into account in the Bank’s forthcoming forecasts.
“It’s hard not to conclude that this will require a significant monetary policy response,” Pill told CEPR’s Barclays Monetary Policy Forum.