The Bank of England has stated that it will intervene to calm markets after the government’s tax-cutting plans prompted a decline in the pound and an increase in borrowing prices.
It cautioned that continuing market volatility would pose a “material danger to the UK’s financial stability.”
The Bank will immediately begin purchasing government bonds to restore “orderly market circumstances.”
Following the release of the news, the pound fell 1.4% versus the dollar to $1.0586.
It comes after the currency hit a record low on Monday following the mini-budget presented by the chancellor.
The Bank has already stated that it will “not hesitate” to increase interest rates to defend the pound and curb rising costs. Some academics expect that the Bank of England would increase the interest rate from the current 2.25 percent to 5.8 percent by the spring of next year.
The forecast has increased borrowing prices, resulting in the withdrawal of hundreds of mortgage products from the market. There are also concerns that pension funds, which frequently invest in government bonds, could be impacted by the market upheaval.
Since the chancellor’s mini-budget on Friday, investors have demanded substantially higher interest rates on Treasury bonds or “gilts” to lend to the government. However, the Bank now intends to reduce these prices by acting as a buyer.
The Bank stated that its bond purchases would be “temporarily limited” and conducted on “whatever size is required” to alleviate investor fears.
It will also delay the launch of a program to sell gilts, which was only announced last week.
Paul Dales, the chief UK economist at Capital Economics, stated that the Bank was compelled to intervene to avert the onset of a financial crisis, and he cautioned that apprehensions regarding the economic outlook were mounting.
This demonstrates that the Bank will do all it can to prevent a financial crisis and that its efforts are already bearing fruit. While this is a positive development, the fact that it was necessary in the first place indicates that the UK markets are in a precarious position.
“It wouldn’t be a major surprise if another financial market problem arose shortly. In either case, the risks to economic development are increasing.
The Bank stated in a statement, “The purchases will be reversed in a seamless and orderly manner whenever concerns to market functioning are deemed to have eased.”
Government bond rates – the effective cost of government borrowing – have soared in recent days, particularly at longer borrowing periods, as investors remain concerned about the UK economy.
It follows the government’s commitment to slash taxes by $45 billion, funded by borrowing, as part of a plan to stimulate economic growth.
On Monday, the British pound reached a record low of $1.0350 due to investors’ concerns over the plan’s affordability.
Some analysts have cautioned that it may potentially equal the dollar.
The government’s plan has received significant condemnation, with the International Monetary Fund warning on Tuesday that the measures are likely to exacerbate the cost-of-living crisis and exacerbate inequality.
The administration has stated that it would not rescind its tax cuts but has pledged to announce additional proposals to stimulate economic growth and reduce the public debt in the next weeks and months.
Treasury confirmed in a statement that global financial markets had experienced “substantial volatility” in recent days.
“The Bank has recognized a danger from recent dysfunction in gilt markets, so from today [28 September], the Bank will temporarily purchase long-term UK government bonds to restore orderly market conditions,” a spokesman said.
In addition, the chancellor is “dedicated” to the Bank’s independence, and “the government will continue to work closely with the Bank to support its financial stability and inflation objectives,” the statement said.
This is a massive display of power by the Bank of England in an attempt to calm the borrowing markets. It does raise some questions.
It emphasizes the severity of the problem and the Bank’s emergency response. The evident cause of this issue was the chancellor’s mini-budget, which resulted in a loss of market confidence and spiraling interest rates on government debt, which might pose a “substantial threat to financial stability,” according to the report.
So it will now, for a limited time, purchase infinite numbers of these debts. The effective interest rate charged to the United Kingdom government in certain markets reached 20-year highs. That has now retreated.
However, the Bank’s Monetary Policy Committee was notified of the decision after it was reached by the Bank’s financial specialists; they did not make the decision themselves. It comes as a surprise because the Committee was planning to liquidate government debts. The procedure was scheduled to begin the next week but has been delayed.
It is a significant intervention, but it could mislead markets regarding policy clarity and responsibility lines. The value of the pound has plunged drastically once more, approaching all-time lows. This will not fix the difficulties facing the government. It could buy them time.
