Bank of England intervenes as Britain enters ‘financial crisis territory’

The central bank of the United Kingdom has announced a drastic intervention in a desperate attempt to stabilise panicking financial markets.

The central bank of the United Kingdom has announced a drastic intervention in an attempt to stabilise the country’s panicking financial markets and struggling currency.

Last Friday the British government, led by the relatively new Prime Minister Liz Truss and Chancellor Kwasi Kwarteng, unveiled a “mini-budget” which included a $75 billion suite of tax cuts, to be funded by $120 billion of public borrowing next year.

The plan was followed by a dramatic plunge in the value of the British pound, which swiftly fell to its lowest level on record against the US dollar. It is now hovering at a value of just above one dollar.

In addition, Britian’s cost of borrowing in international markets spiked, rising above the rates of even debt-ridden nations like Italy and Greece.

British Prime Minister Liz Truss leaving Downing Street earlier this week. Picture: Rob Pinney/Getty Images

In a statement released on Wednesday night, Australian time, the Bank of England expressed deep concerns about “significant repricing of UK and global financial assets”.

And the central bank announced its intention to intervene in bond markets.

“This repricing has become more significant in the past day, and it is particularly affecting long-dated UK government debt. Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability,” it said.

“This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.

“In line with its financial stability objective, the Bank of England stands ready to restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses.

“To achieve this, the Bank will carry out temporary purchases of long-dated UK government bonds from September 28. The purpose of these purchases will be to restore orderly market conditions. The purchases will be carried out on whatever scale is necessary to effect this outcome. The operation will be fully indemnified by His Majesty’s Treasury.

“Auctions will take place from today until October 14. The purchases will be unwound in a smooth and orderly fashion once risks to market functioning are judged to have subsided.”

The Bank’s monetary policy committee will “make a full assessment of recent macroeconomic developments” at its next scheduled meeting. The statement said the committee would “not hesitate to change interest rates by as much as needed” to curb inflation.

The Bank of England. Picture: Daniel Leal/AFP

The central bank’s intervention followed criticism from the International Monetary Fund, which warned the government’s mini budget could increase inequality and worsen the nation’s already skyrocketing inflation.

Credit ratings agency Moody’s also waded in with a warning about soaring debt.

Moody’s called Britain’s new fiscal policy regime “credit negative”, adding that a sustained confidence shock could “permanently” weaken its debt affordability.

Mr Kwarteng’s big tax cuts and energy price freeze, aimed at boosting the UK’s recession-threatened economy, appeared to have had the opposite effect as traders warn of ballooning debt to pay for the incentives.

Following last Friday’s mini budget, UK government bond yields have soared and the pound hit a record low at $1.0350 on Monday.

Critics argue Mr Kwarteng’s measures would benefit the rich more than the poorest, as millions of Britons suffer from a cost-of-living crisis.

“We have acted at speed to protect households and businesses through this winter and the next, following the unprecedented energy price rise,” the Treasury said as it sought to defend itself.

“We are focused on growing the economy to raise living standards for everyone,” it added, blaming sky-high oil, gas and electricity prices on Russia’s invasion of Ukraine.

In a highly unusual intervention, the IMF late on Tuesday said it was “closely monitoring” developments and urged the government in London led by Ms Truss to change tack.

The IMF added: “We understand that the sizeable fiscal package announced aims at helping families and businesses deal with the energy shock and at boosting growth via tax cuts and supply measures.

“However, given elevated inflation pressures in many countries... we do not recommend large and untargeted fiscal packages at this juncture.”

The IMF said the “UK measures will likely increase inequality” and stressed the importance of fiscal policy not working “at cross purposes to monetary policy”.

Chancellor of the Exchequer Kwasi Kwarteng. Picture: Jeff Overs/AFP

Analysts warned that Britain’s controversial measures could force the Bank of England to hike interest rates far higher than forecast.

“Expectations that there will be a super-sized interest rate hike coming from the Bank of England to try and counter the government splurge on tax cuts and spending have increased,” Hargreaves Lansdown analyst Susannah Streeter noted on Wednesday.

Many central banks, including the BoE, are aggressively hiking interest rates in a bid to cool decades-high inflation.

The central bank’s intervention announcement did provide some immediate respite, with long-dated bonds rallying. But experts warned the fact the intervention was needed in the first place was a bad sign.

“This is ...... bad,” said The Financial Times’ economics editor Chris Giles.

“Entirely self-inflicted wound, forcing the Bank of England to restart the printing presses to bail out pension funds which were falling over this morning, because no one in financial markets liked the ‘mini Budget’.

“This is now financial crisis territory.”

Paul Dales, chief UK economist at Capital Economics, said the Bank of England was acting to “prevent this from escalating into a full-blown financial crisis”.

“While this is welcome, the fact that it needed to be done in the first place shows that the UK markets are in a perilous position,” Mr Dales.

“It wouldn’t be a huge surprise if another problem in the financial markets popped up before long. Either way, the downside risks to economic growth are growing.”

In the broader media, meanwhile, some critics focused on Ms Truss’s silence.

“Where the hell is the Prime Minister?” fumed broadcaster Piers Morgan.

“Stop hiding, Liz Truss, and face the hideous financial chaos music you’ve unleashed.”

– with AFP