LONDON- The Bank of England said it would not hesitate to change interest rates and was monitoring markets “very closely”, after the pound plunged to a record low and British bond prices collapsed in response to the new government’s financial plans.
Finance minister KwasiKwarteng sent sterling and government bonds into freefall on Friday with a so-called mini-budget that was designed to grow the economy by funding tax cuts with huge increases in government borrowing.
Such was the market turmoil on Monday there was growing speculation in financial markets that the BoE would make an emergency interest rate rise after it hiked rates only last week to 2.25 percent from 1.75 percent.
Instead, with the pound fragile and bond prices still tumbling, Kwarteng issued a statement just before the British stock market closed to say he would set out medium-term debt-cutting plans on Nov. 23, alongside forecasts from the independent Office for Budget Responsibility of the full scale of government borrowing.
The central bank welcomed “the commitment to sustainable economic growth” from Kwarteng and the independent scrutiny that the OBR growth and borrowing forecasts would bring.
“The Bank is monitoring developments in financial markets very closely in light of the significant repricing of financial assets,” Bank of England Governor Andrew Bailey said.
“The MPC will not hesitate to change interest rates by as much as needed to return inflation to the 2 percent target sustainably in the medium term, in line with its remit.”
US Federal Reserve official Raphael Bostic said the market moves could lead to greater economic stress in Europe and the United States, while analysts and investors said the government had done the bare minimum to reassure markets. [nL1N30X1LG]
“There seems no reason to believe that markets will give the government the benefit of the doubt ahead of a new fiscal plan by KwasiKwarteng,” said Chris Scicluna, head of economic research at Daiwa Capital Markets.
“The market could force their hand and there still could be an emergency rate hike before the next BoE meeting,” he said, referring to the next scheduled policy announcement on Nov. 3.
The Treasury and central bank statements came towards the end of a day of turmoil for Britain’s currency and debt.
While the pound plunged by as much as 5 percent against the dollar to touch $1.0327, its weakest on record, in Asian trade, it had pared most of the day’s losses in European trading on hopes of an emergency rate hike.
The statement at the close of trading on Monday pushed the pound back to as low as $1.0645 from $1.0820. Sterling was trading at $1.0680, down 1.6 percent on the day.
In the market for British government bonds, or gilts, the pressure had been even more intense, with five-year bond prices GB5YT=RR recording their joint-biggest daily fall since at least 1991, matching Friday’s historic slump.
The five-year gilt’s yield GB5YT=RR – the cost for the British government of new borrowing over five years – reached its highest since September 2008 at 4.603 percent, and has risen a full percentage point in the last two trading days as Prime Minister Liz Truss’s government lost credibility with investors.
“The reaction to the proposed plan is a real concern and a fear that the new actions will add uncertainty to the economy,” Atlanta Fed President Bostic told the Washington Post.
“The key question will be what does this mean for ultimately weakening the European economy, which is an important consideration for how the US economy is going to perform.”
With markets remaining hugely volatile, British lenders Halifax, Virgin Money and Skipton Building Society withdrew mortgage products from the market.
Gilt yields showed little reaction to the BoE and government statements, but very short-term interest rate swaps slashed the odds of an emergency rate rise in the coming week.
Mohamed El-Erian, chief economic adviser at Allianz, had earlier said the central bank would have no choice but to raise interest rates if Truss and Kwarteng did not back down.
“And not by a little, by 100 basis points, by one full percentage point to try and stabilize the situation,” he told BBC Radio.
Truss, Britain’s former foreign secretary, was elected as prime minister earlier this month by a vote of the Conservative Party’s 170,000 members – not the broader electorate – after an internal party rebellion that drove Boris Johnson out of power.
She largely beat her rivals to the top job by vowing to reignite economic growth through tax cuts and deregulation to bring an end to the largely stagnant real wage growth that has marked her party’s 12 years in government. — Reuters
