The British central bank intervenes in the market to stem the economic crisis

The Bank of England has taken emergency action to stabilize Britain’s financial markets and avert a crisis in the wider economy after the government spooked investors with a package of unfunded tax cuts, plunging the pound and drive up the cost of public debt.

The central bank warned that eroding confidence in the economy posed a “significant risk to the UK’s financial stability”, while the International Monetary Fund took the rare step of urging a member of the Group of seven advanced economies to abandon its plan to cut taxes and increase borrowing to cover costs.

The Bank of England said it would buy long-term government bonds over the next two weeks to combat a recent decline in UK financial assets. The bank’s shares focus on long-term government debt, where yields have soared in recent days, driving up government borrowing costs.

“If the dysfunction of this market continues or worsens, there would be a significant risk to the financial stability of the UK,” the bank said in a statement. “This would lead to an unwarranted tightening of financing conditions and a reduction in the flow of credit to the real economy.”

The move came five days after Prime Minister Liz Truss’ new government sparked investor concern by unveiling an economic stimulus package that included 45 billion pounds (NZ$85 billion) in tax cuts. and no reduction in expenses. He also wants to spend billions to help protect homes and businesses from soaring energy prices, sparking fears of spiraling public debt and higher inflation, which is already nearing a peak. 40 years of 9.9%.

The pound plunged to a record low against the US dollar on Monday after the government announcement, and UK government debt yields soared. Yields on 10-year government bonds have risen 325% this year, making it much more expensive for the government to borrow to fund its policies.

The Bank of England’s plan to buy government debt helped stabilize the bond market, with 10-year bond yields falling to 4.235% by midday in London.

Yields, which measure the return buyers receive on their investment, had risen to 4.504% on Tuesday from 3.495% the day before the tax cuts were announced.

The pound was trading at US$1.0628 on Wednesday in London, after rebounding from a record low of US$1.0373 on Monday. The British currency is still down 4% since Friday, and it has fallen 20% against the dollar in the past year.

Opposition parties have demanded parliament be recalled from a two-week break to deal with the economic crisis. But Truss and Treasury chief Kwasi Kwarteng has remained silent and out of sight, betting the economic storm will pass.

Northern Ireland Secretary Chris Heaton-Harris, one of the few government ministers present on Wednesday, said the government’s policies would “make my country richer and more prosperous”.

“I think you’ll find that economic policy takes longer than two days,” he said.

On Monday, the Bank of England had refrained from an emergency interest rate hike to offset the fall in the pound, but said it would be willing to raise rates if necessary.

But the bank’s next scheduled meeting isn’t until November, and the lack of immediate action has done little to support the pound. The bank was able to intervene immediately with bond purchases because its financial policy committee has the mandate to ensure the stability of the financial system.

The UK government said it had fully backed central bank intervention in government bonds, known as gilts.

“The Bank has identified a risk of recent dysfunction in the gilt markets, so it will temporarily purchase long-term UK government bonds from today in order to restore market conditions orderly,” the Treasury said in a statement.

The UK government resisted pressure to reverse the trend, but said it would present a more detailed budget plan and independent analysis of the Office for Budget’s accountability on November 23.

Kwarteng met on Wednesday with executives from investment banks including Bank of America, JP Morgan, Standard Chartered and UBS in a bid to appease markets alarmed by his economic plans.

The Treasury said Kwarteng underscored the government’s “clear commitment to fiscal discipline” and promised further steps soon to boost economic growth, including deregulation of financial services.

The central bank was prompted to act after volatility in financial markets spread across the economy, increasing borrowing costs for the government, limiting mortgage options for homebuyers and forcing some funds pension funds to sell long-term government bonds used to manage risk.

Some analysts believe the recent surge in bond yields has added around £20bn to the cost of servicing the UK’s bloated debt.

In addition, UK mortgage lenders pulled hundreds of offers from the market as the Bank of England is expected to raise interest rates sharply to offset the inflationary impact of the recent fall in the pound.

The market’s reaction to the government’s plans also revealed the vulnerabilities of UK pension funds. In particular, some defined benefit pension schemes, where employers assume the risk of guaranteed payouts to their retirees, have been forced to sell long-term bonds to cover their liabilities, creating the possibility of a downward spiral. prices.

“The extraordinary intervention came amid growing fears that defined benefit pension funds… could be hit by the fall in the value of the pound and the sharp moves in the long-term gilt market” , said Alice Haine, personal finance analyst. at Bestinvest.

Jagjit Chadha, director of the National Institute for Economic and Social Research, described Wednesday’s action as a traditional central bank intervention to limit market turbulence.

“What we need is a little calm, a preparation to engage in the way we think policies should be designed these days, which is to say a review deepened by experts and an understanding of its impact on the economy and a limit to disruptive trends,” he said. “You know, we don’t need to disrupt this economy anymore.”