Bank of England seeks to stem bond market turmoil

  • The IMF does not “recommend” policies like the UK growth plan
  • Moody’s: Economic plan is “growth negative”
  • The pound traded up 0.7% to $1.065
  • Bond strategists warn of almost non-tradable market

LONDON, Sept 28 (Reuters) – The Bank of England tried to quell a firestorm in Britain’s bond market and said on Wednesday it would buy as many government bonds as needed to maintain financial stability after the new government’s fiscal policy restore the chaos that was triggered .

After failing to cool off the sell-off with verbal intervention for the previous two days, the BoE announced an emergency measure which it said would prevent the turmoil from spreading across markets and hurting credit flows .

“Should dysfunction in this market persist or worsen, there would be a significant risk to UK financial stability,” the central bank said in a statement, which immediately eased pressure on rising UK government bond yields.

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The Treasury said it would fully compensate the operations.

Sterling fell 0.7% to $1.065 after falling to a session low of $1.0618.

The BoE said it is sticking to its target of reducing its £838 billion ($892 billion) gilt holdings by £80 billion next year but will delay the start of sales – due to start next week – due of market conditions shift.

Earlier, the International Monetary Fund and ratings agency Moody’s had increased pressure on Britain to reverse its new strategy laid out by incoming finance minister Kwasi Kwarteng on Friday to boost economic growth.

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The rare intervention by the IMF, the global lender of last resort, on a G7 country underscored the gravity of the situation Britain is facing as the value of the pound and UK bonds have collapsed since Friday.

The Bank of England said on Monday it would not hesitate to raise interest rates and was “monitoring markets very closely”. On Tuesday, its chief economist Huw Pill said the central bank is likely to come up with a “significant” rate hike at its next meeting in November.

Despite these comments, the market remained in turmoil.

Earlier on Wednesday, 30-year UK government bond yields rose above 5% for the first time since 2002. 30-year government bond yields fell more than 50 basis points on the day following the BoE statement.

The latest crisis to hit the British state was sparked by Kwarteng’s plans for deep tax cuts and deregulation to wriggle the economy out of a long period of stagnation seen as a return to the Thatcher-Reaganomist doctrines of the 1980s.

Mortgage lenders withdrew hundreds of products as the cost of UK borrowing rose, and anecdotal reports said people were struggling to get through to lenders to either make or change mortgage deals.

That would come as a major shock in a country where rising house prices have conveyed a sense of general prosperity for years and where homebuyers have become accustomed to more than a decade of rock-bottom interest rates.

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The IMF said the proposals, which sent the pound to an all-time low of $1.0327 on Monday, would contribute to a credibility crisis after the government cut taxes and increased borrowing while the Bank of England is raising interest rates fight rising inflation.

“Given the heightened inflationary pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this time, as it is important that fiscal policy does not conflict with monetary policy,” said an IMF spokesman.

Jim Reid, research strategist at Deutsche Bank, called the “rebuke” “pretty scathing.”

HUMILIATION

The IMF is symbolic in British politics: its 1976 bailout after a balance of payments crisis forced huge spending cuts and has long been seen as a humiliating low point in the country’s modern economic history.

The UK crisis is also being watched around the world, and Spain’s socialist economy minister, Nadia Calvino, is using it to attack her conservative opposition.

“We’re all able to see how it’s leading the country not astray, but into disaster,” she said. “An irresponsible, destructive fiscal policy.”

In a blunt press release, Moody’s said large, unfunded tax cuts were “credit negative” for the UK and risked structurally higher funding costs that could weaken the economy.

Kmacheng, an economic historian who was economy minister for two years, has responded to the criticism by insisting that tax cuts for the wealthy, along with support for energy prices, are the only way to restart economic growth.

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The IMF said its Nov. 23 fiscal plan would give the UK government an “early opportunity to explore ways to provide more targeted support and to reassess tax measures, particularly those that benefit high-income people”.

The UK Treasury said the November announcement would detail the government’s medium-term debt reduction plans.

“We are focused on growing the economy to raise living standards for all,” a spokesman said.

Amid growing concern in the financial sector and among lawmakers in the ruling Conservative Party, Kwarteng has spoken with banking, insurance and financial sector chiefs and will meet with more bank chiefs on Wednesday.

Speaking on Tuesday, BoE chief economist Pill said the financial market turmoil is having a major impact on the economy and will factor into the bank’s next forecasts.

“It’s hard not to conclude that this will require a significant policy response,” Pill told the CEPR Barclays Monetary Policy Forum. ($1 = 0.9330 pounds)

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writing by Kate Holton; Additional reporting by William James, Dhara Ranasinghe, David Milliken, Sachin Ravikumar and William Schomberg in London and Emma Pinedo Gonzalez in Madrid; Edited by Alex Richardson, Catherine Evans and Toby Chopra

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