For the second time in two days, the Bank of England was forced to offer further support to UK markets still reeling from the government’s announcement last month that it would cut taxes and increase borrowing.
The central bank warned on Tuesday that there was still a ‘significant risk to the financial stability of the UK’ as a sharp sell-off in government bonds pushed yields higher, driving up the costs of borrowing across the economy and forcing some pension funds to shed assets to raise cash.
A slump in UK government bonds that promise to protect investors from inflation – known as pegged gilts – was the latest source of risk, he said.
“The dysfunction of this market and the prospect of a self-reinforcing ‘fire-selling’ dynamic pose a significant risk to the financial stability of the UK,” it said in a statement.
From Tuesday, the Bank of England will include pegged gilts in its £65 billion ($71.7 billion) emergency bond purchase program announced on September 28. “These additional operations will serve as an additional safety net to restore orderly market conditions.” he added. The bank said the program would end as scheduled on Friday.
On Monday, it doubled the daily limit on its bond purchases to £10bn until the end of the week. He also announced a new facility that will make it easier for banks to tap central bank liquidity by accepting a wider range of assets as collateral. This program will continue after the emergency bond purchase program ends.
The market crash began after Prime Minister Liz Truss’ government unveiled £45billion in unfunded tax cuts on September 23. watchdog, the Office for Budget Responsibility (OBR), of what the plan would mean for public borrowing and economic growth.
The pound and UK government bonds crashed, forcing some pension funds to the brink of default and pushing them to dump assets as a hedging strategy unblocked. Mortgage rates have skyrocketed.
Under pressure from markets, the International Monetary Fund, rating agencies, polls and wayward members of their own conservative party, Truss and Kwarteng have already had to backtrack quickly. They have dropped plans to cut the top tax rate for people earning over £150,000 a year, but that only cuts the cost of the tax cut scheme by around £2billion.
Kwarteng has also moved its full budget announcement forward by more than three weeks to October 31, meaning it will now take place ahead of the next Bank of England meeting on November 3, when interest rates are expected to rise significantly. significant. The Minister of Finance will also release the OBR forecast at the same time.
But the government still faces an uphill struggle to persuade investors that it can pay for its program and deliver on Kwarteng’s promise of “lower debt over the medium term”.
The Independent Institute for Fiscal Studies said on Tuesday the government would have to announce spending cuts of more than £60billion just to stabilize debt as a share of national income by 2026-27.
These cuts may be politically impossible to achieve given the crisis in the cost of living and the pressure on public services such as health and social services.
“It is roughly possible to see how Mr Kwarteng could go into debt on a flat or slightly declining trajectory over the final year of his forecast,” IFS director Paul Johnson said in a statement. communicated. “But the details of the UK government’s fiscal strategy are more scrutinized by financial markets than at any time in the recent past.”
Relying on overly optimistic growth forecasts or vague promises of spending cuts could lack credibility.
Benjamin Nabarro, chief UK economist at Citigroup, said the UK had few easy answers to the tough economic outlook.
“In the short term, further demand stimulation may simply compound the short-term challenges. And with monetary and fiscal policy now working in opposite directions, we believe the wider risks around UK monetary policy [and] financial stability are getting stronger,” he added.
— Julia Horowitz and Hanna Ziady contributed to this article.