Bank of England seeks to stem bond market turmoil after tax cut storm

By Andy Bruce and David Milliken

LONDON (Reuters) -The Bank of England sought to quell a fire-storm in Britain’s bond markets, saying it would buy as much government debt as needed to restore order after new Prime Minister Liz Truss’ tax cut plans triggered financial chaos.

Having failed to cool the sell-off with verbal interventions over the previous two days, the BoE announced on Wednesday the immediate launch of its emergency bond-buying programme aimed at preventing the market turmoil from spreading.

The plan delivered by Truss’s finance minister Kwasi Kwarteng on Friday for tax cuts on top of an energy bill bailout, all funded by a huge increase in government borrowing, quickly led to a freezing of mortgage markets, selling of gilts by pension funds and a leap in corporate borrowing costs.

It also triggered alarm in foreign capitals.

“Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability,” the British central bank said.

It said it would buy up to 5 billion pounds ($5.31 billion) a day of British government bonds of at least 20 years’ maturity starting on Wednesday and running until Oct. 14.

The announcement, which represented a sudden reversal of the BoE’s plans to start selling bonds it had amassed since the global financial crisis of 2008-08, immediately pushed down borrowing costs.

The 30-year gilt yield was set for its biggest drop in records going back to 1992.

But sterling fell by about 1% against the dollar and euro, putting it on track for its biggest monthly decline since October 2008, just after Lehman Brothers collapsed.

By 2:48pm (1348 GMT) it was trading down 0.5% at $1.0679, a fall of 12% in the last three months.

The BoE said it would return to its plan to sell bonds and its launch was only postponed until the end of October.

Kwarteng’s plans for deep tax cuts and deregulation to snap the economy out of a long period of stagnation were seen as a return to Thatcherite and Reaganomics doctrines of the 1980s.

But they have caused panic among some investors and disquiet among many lawmakers of the ruling Conservative Party.

RESTORE ORDER

On Monday the BoE said 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 was likely to deliver a “significant” rate increase when it meets next in November.

But the slide in bond prices continued unabated on Wednesday, prompting the BoE to make its move.

“The purpose of these purchases will be to restore orderly market conditions,” it said. “The purchases will be carried out on whatever scale is necessary to effect this outcome.”

Officials in international governments and financial institutions have started to go public with their criticism of UK policy.

In a rare intervention over a G7 country, the International Monetary Fund urged Truss to reverse course.

Ratings agency Moody’s said the policy risked structurally higher funding costs that would be “credit negative” for Britain.

Spain’s Economy Minister Nadia Calvino was more blunt, calling the policy a disaster and Ray Dalio, co-chief investment officer of the world’s largest hedge fund Bridgewater Associates, said he could not believe London’s mistakes.

“The panic selling you are now seeing that is leading to the plunge of UK bonds, currency, and financial assets is due to the recognition that the big supply of debt that will have to be sold by the government is much too much for the demand,” Dalio said on Twitter.

Julian Jessop, an economist who provided informal advice to Truss during her leadership campaign, said the economy was at risk of falling into a “doom loop”.

MARKET FRENZY

So far the government has refused to budge.

Kwarteng, an economic historian who was business minister for two years and a free-marketeer by conviction, has insisted that tax cuts for the wealthy alongside support for energy prices are the only way to reignite long-term economic growth.

He has said he will publish a medium-term debt-cutting plan on Nov. 23, which the IMF described as an “early opportunity for the UK government to consider ways to provide support that is more targeted and re-evaluate the tax measures, especially those that benefit high-income earners”.

The frenzy in markets and the ensuing alarm in the ruling Conservative Party will put huge pressure on Kwarteng and Truss. She was elected by the party’s roughly 170,000 members, not the broader electorate.

Conservative lawmaker Simon Hoare, who backed Truss’s rival Rishi Sunak for the leadership of the party, pointed the finger of blame at the government and Treasury for the policies that sparked the market rout.

“They were authored there. This inept madness cannot go on,” he said.

One area of immediate concern for politicians is the mortgage market, after lenders pulled record numbers of offers and anecdotal reports suggested people were struggling to either complete or change mortgage deals.

A slump in the housing market would mark a major shock in a country where rising house prices have for years conveyed a sense of overall affluence, and where home buyers have got used to more than a decade of rock-bottom interest rates.

The intervention of the IMF holds symbolic importance in Britain: its bailout in 1976 following a balance-of-payments crisis forced huge spending cuts and has long been regarded as a humiliating low point in the country’s modern economic history.

(Writing by Kate Holton; Additional reporting by William James, Dhara Ranasinghe, David Milliken, Sachin Ravikumar, Paul Sandle, Muvija M and William Schomberg in London and Emma Pinedo Gonzalez in Madrid; Editing by Alex Richardson, Catherine Evans, Toby Chopra and William Schomberg)