The Bank of England moves to calm the bond market after the storm of tax cuts

LONDON, Sept 28 (Reuters) – The Bank of England sought to quell the firestorm 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 sparked financial chaos.

After failing to cool the sell-off with verbal interventions over the previous two days, the Bank of England announced on Wednesday the immediate launch of an emergency bond-buying program aimed at preventing market turmoil from spreading.

“If the dysfunction in this market were to continue or worsen, there would be a significant risk to the UK’s financial stability,” the BoE warned.

Since Finance Minister Kwasi Kwarteng on Friday outlined a plan for tax cuts on top of an energy bill bailout, all funded by a huge increase in government borrowing, UK mortgage markets have frozen, pension funds have dumped gilts and corporate borrowing costs have soared.

A Treasury source said Kwarteng would not resign and the government would not reverse its policy. Another person familiar with the situation said Truss remains supportive of Kwarteng and will soon announce further economic reforms.

The BoE will now buy up to 5 billion pounds ($5.31 billion) per day of British government bonds with maturities of at least 20 years from Wednesday until October 14.

The announcement, which represented a sudden reversal of plans to sell bonds it had been hoarding since the 2008-9 global financial crisis, immediately pushed down borrowing costs.

The 30-year gilt yield was set for its biggest fall in records dating back to 1992. The pound pared earlier losses to rise against the dollar. At $1.0860, it was up 1.2% on the day and down 11% over the past three months.

The BoE said it would return to its plan to sell bonds at the end of October.

But the political and economic shock waves that have triggered increasing alarm in foreign capitals continued to reverberate.

Kwarteng sought to reassure investment bankers in a meeting described by participants as nervous, and two senior BoE officials pulled out of public events planned for Wednesday and Thursday.

A source at the meeting said Kwarteng had asked the assembled finance chiefs what they could do to calm the markets.

“It wasn’t lost on them that he was putting the problem in their lap,” this source said.

Investors and economists have said the government’s plan to wait until Nov. 23 to set out its full debt-reduction policy, and the fact that the BoE’s next interest rate announcement is not scheduled until Nov. 3, seemed at odds with the market frenzy.

“Truss and Kwarteng now face a serious economic crisis as the world’s financial markets wait for them to make policy changes that they and the Conservative Party will find unpalatable,” said Mujtaba Rahman of the Eurasia Group.

RESTORE ORDER

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

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

Such was the pressure in the markets that pension schemes sold gilts to meet emergency collateral requirements on underwater derivative positions, or sold to reduce exposure, as they could not meet those cash sums, pension advisers said.

“There are schemes that are running out of cash at the moment,” one pensions consultant said ahead of the BoE intervention. Another person familiar with the decision confirmed that the BoE moved because of problems facing pension funds, the main holders of long-dated gilts.

The BoE said the purchases were designed to restore orderly market conditions. “The purchases will be made on the scale necessary to achieve this result.”

Foreign government officials and international financial institutions have begun to make their criticism public.

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

US bond giant PIMCO said it would have less confidence in sterling than before last Friday’s announcement.

Spain’s Economy Minister Nadia Calvino was more fair, calling the policy a disaster.

MARKET FRENCH

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 rich along with support for energy prices are the only way to revive long-term economic growth.

The agitation in the markets and subsequent alarm among Conservative lawmakers will put huge pressure on him and Truss, who was elected by the party’s 170,000 or so members, not the wider electorate. The party will hold its annual conference next week.

Conservative lawmaker Simon Hoare, who backed Truss’s rival Rishi Sunak for the leadership, blamed the government and the Treasury for the policies that triggered the market disruption.

“They were written there. This inept madness cannot continue,” he said.

One area of ​​immediate concern for policymakers is the mortgage market, after lenders withdrew a record number of offers and anecdotal reports suggested people were struggling to either complete or change mortgage agreements.

A downturn in the housing market would mark a major shock in a country where rising house prices have for years conveyed a sense of general prosperity, and where homebuyers have become accustomed to more than a decade of rock-bottom interest rates.

The intervention of the IMF also has symbolic significance in Britain: the bailout in 1976 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.

Written by Kate Holton; Additional reporting by Elizabeth Piper, William James, Dhara Ranasinghe, Carolyn Cohn, Sachin Ravikumar, Paul Sandle, Muvija M and William Schomberg in London and Emma Pinedo Gonzalez in Madrid; Editing by Alex Richardson, Toby Chopra, William Schomberg and Catherine Evans

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