Summary
- BoE begins buying bonds, halts gilt sales
- IMF does ‘not recommend’ policies like UK growth plan
- Fin min Kwarteng and PM Truss face criticism for policy
- Pound trading down 0.7% to $1.065
- Kwarteng meets banking executives again
The Bank of England sought to calm the fire-storm in Britain’s bond markets, saying it would buy as much government debt as necessary to bring back order after new Prime Minister Liz Truss’s tax cutting plans sparked financial turmoil.
Having failed to quell the sell-off with verbal interventions over the past two days, the British central bank declared on Wednesday the immediate launch of an emergency bond-buying programme focused on hindering the market turmoil from spreading.
The BoE warned:
“Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability.”
Since finance minister Kwasi Kwarteng drafted a plan on Friday for tax cuts in addition to an energy bill bailout, all funded by a vast increase in government borrowing, UK mortgage markets have crashed, corporate borrowing costs have increased, and pension funds have abandoned gilts.
One source at the Treasury said Kwarteng would not step down, and the government would not overturn its policy. A second person with knowledge of the matter said Truss still supported Kwarteng and they would declare further economic reforms soon.
The BoE will now purchase up to 5 billion pounds ($5.31 billion) a day of British government bonds of at least 20 years’ maturity beginning on Wednesday and extending until Oct. 14.
Its announcement, which indicated an abrupt reversal of plans to sell bonds it had obtained since the global financial crisis of 2008-9, immediately reduced borrowing costs.
The 30-year gilt yield was set for its largest slump in records dating back to 1992. The pound reduced earlier losses to rise against the dollar. At $1.0860, it gained 1.2% on the day and down 11% in the last three months.
The BoE said it would resume its plan to sell bonds at the end of next month. But the economic and political shockwaves that have prompted mounting fear in foreign capitals continued to reverberate.
Kwarteng sought to cheer up investment bank executives in a meeting classified by attendees as nervous, and two senior BoE officials back out of public events planned for Wednesday and Thursday. One source at the meeting said Kwarteng had asked the assembled finance executives what they could do to quell markets.
The source stated:
“It wasn’t lost on them that he put the problem in their laps.”
Economists and investors have said the government’s plan to wait until Nov. 23 to launch its full debt-cutting policy, and the fact the BoE’s next rate announcement is not due until Nov. 3, seemed at odds with the market chaos.
Eurasia Group’s Mujtaba Rahman said:
“Truss and Kwarteng are now facing a severe economic crisis as the world’s financial markets wait for them to make policy changes that they and the Conservative Party will find unpalatable.”
Restore Order
Kwarteng’s plans for huge tax cuts and deregulation to revive the economy from a long period of downturn were seen as a return to Thatcherite and Reaganomics doctrines of the 1980s. But they have caused alarm among some investors and unease among many lawmakers of the ruling Conservative Party.
Such were the pressures in the markets that pension schemes were selling gilts to fulfill emergency collateral calls on under-water derivatives positions, or selling to lower their exposure as they could not fulfill those cash calls, pension advisers said.
“There are schemes running out of cash at the moment,” one pension consultant said before the BoE’s intervention. Another person familiar with the decision corroborated that the BoE moved because of problems facing pension funds, the major holders of long-dated gilts.
The BoE said the purchases were designed to re-establish orderly market conditions. “The purchases will be carried out on whatever scale is necessary to effect this outcome.”
International financial institutions and foreign government officials have begun to go public with their criticism. In a rare intervention over a G7 country, the International Monetary Fund advised Truss to change course. U.S. bond giant PIMCO said it would have little confidence in the pound than it did before last Friday’s announcement.
Nadia Calvino Spain’s Economy Minister was more forthright, regarding the policy as a disaster.
Market Frenzy
Until now, the government has refused to reverse course.
Kwarteng, an economic historian who was a free-marketeer by conviction and business minister for two years, has maintained that tax cuts for the wealthy together with support for energy prices are the only way to revive long-term economic growth.
The turbulence in markets and resulting alarm among Conservative lawmakers will put great pressure on him and Truss, who was appointed by the party’s roughly 170,000 members, and not the general electorate. The party convenes for its annual forum next week.
Simon Hoare, a Conservative lawmaker who supported Truss’s rival Rishi Sunak for the leadership, accused the government and Treasury of the policies that triggered the market rout. He said:
“They were authored there. This inept madness cannot go on.”
One area of serious concern for politicians is the mortgage market, after lenders drew record numbers of offers and anecdotal reports indicated people were grappling to either complete or change mortgage deals.
A slowdown in the housing market would indicate a major shock in a country where surging house prices have for years projected a sense of overall affluence, and where home buyers have gotten used to more than ten years of low-interest rates.
The intervention of the IMF also holds symbolic significance in Britain: its bailout in 1976 following a balance-of-payments crisis caused huge spending cuts and has long been described as a demeaning low point in the country’s modern economic history.
