The Bank of England said on Monday 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 Kwasi Kwarteng 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.
With the pound fragile and bond prices still tumbling on Monday, Kwarteng released a statement after UK stock markets closed, saying he would set out his medium-term fiscal plans on Nov. 23, along with growth and borrowing forecasts from the Office for Budget Responsibility, a government watchdog.
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% target sustainably in the medium term, in line with its remit.”
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% 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 $1.0720 at 1557 GMT.
INTENSE MARKET PRESSURE
In the market for British government bonds, or gilts, the pressure had been even more intense, with five-year bond prices on track for their second-biggest daily fall since at least 1991, behind only Friday’s historic slump.
The two-year gilt yield, the cost for the British government of borrowing over two years, reached its highest since September 2008 at 4.573%, up a full percentage point in the last two trading days as Prime Minister Liz Truss’s government lost credibility with investors.
Gilt yields showed little reaction to the combined statements, but very short-term interest rate futures 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 stabilise 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 – following 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.
Her pledge to end so-called “Treasury orthodoxy” and go for growth marked a step change in British financial policy, harking back to the Thatcherite and Reaganomics doctrines of the 1980s. “Markets go up and down,” one veteran Conservative Party source said, declining to be named. “We did something structural, short term, that will have seismic and positive long term benefits.”