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London
CNN Business
–
For the second time in two days, the Bank of England has been forced to provide additional support to UK markets still reeling from the government’s announcement last month that it would cut taxes and raise debt.
The central bank warned on Tuesday that there was still a “material risk to UK financial stability” from a sharp selloff in government bonds that has pushed up yields, raised borrowing costs across the economy and forced some pension funds to build assets. Cash
The latest source of risk was a slowdown in UK government bonds – known as index-linked gilts – that promise to protect investors from inflation, he said.
“The dysfunction in this market, and the potential for self-reinforcing ‘fire cell’ dynamics, pose a material risk to the UK’s financial stability,” it said in a statement.
The extent of the bond market strain was underlined on Tuesday when £900 million ($994 million) of index-linked gilts due 2051 were sold at the highest yields since October 2008, according to Reuters.
Starting Tuesday, the Bank of England will include index-linked gilts in its emergency £65 billion ($71.7 billion) bond-buying program announced on September 28. It added.
The bank said the program will end as planned on Friday, despite calls to extend it for another three weeks.
On Monday, it doubled its daily limit on bond-buying to £10 billion by the end of the week. It also announced a new facility that will make it easier for banks to tap central bank cash by accepting a wider range of assets as collateral. That program will continue after the emergency bond-buying program ends.
The market slump began after Prime Minister Liz Truce’s government unveiled £45 billion in unfunded tax cuts on September 23. Truss and his finance minister, Kwasi Kwarteng, also chose to present their “mini budget” without independent analysis of the UK’s financial year. The watchdog, the Office for Budget Responsibility (OBR), will discuss what the plan will mean for government borrowing and economic growth.
The pound and UK government bonds collapsed, forcing some pension funds closer to default and forcing them to dump assets as hedging strategies stalled. Mortgage rates shot higher.
Under pressure from markets, upset members of the International Monetary Fund, rating agencies, poll ratings and their own Conservative Party, Truss and Quartet, have already had to quickly back down. They have dropped plans to cut the top rate of income tax for those earning more than £150,000 a year, but that leaves just £2 billion off the cost of the tax-cutting package.
Kwarteng has also pushed back his full budget announcement by more than three weeks to October 31, meaning it will now take place before the Bank of England’s next meeting on November 3, when a significant rate hike is likely. The Finance Minister will also publish the OBR forecast at the same time.
But the government still faces an uphill battle in convincing investors that it can pay for its program and fulfill Kwarteng’s promise to “reduce debt in the medium term.”
The Pensions and Lifetime Savings Association, which represents funds providing retirement income for 30 million people, said many of its members wanted to see the Bank of England continue buying bonds until the end of the month, and possibly beyond.
The government will need to announce spending cuts of just over £60 billion by 2026-2027 to stabilize debt as a share of national income, the independent Institute for Fiscal Studies said on Tuesday.
Those cuts may be politically impossible given the cost-of-living crisis and the pressure on public services such as health and social care.
IFS director Paul Johnson said in a statement that ‘it is almost possible to see how Mr Kwarteng could get debt on a steady, or ever-so-slightly declining, path in the final year of his forecast. “But the specifics of the UK government’s monetary strategy are under greater scrutiny by financial markets than at any time in the recent past.”
Relying on overly optimistic forecasts for growth or vague promises to cut costs down the road can lack credibility.
Benjamin Nabarro, chief UK economist at Citigroup, said the United Kingdom had few easy answers to the difficult economic outlook.
“In the near term, further demand stimulus may only exacerbate near-term challenges. And with monetary and fiscal policy now working in the opposite direction, we think the broader risks surrounding UK finances [and] Financial stability is increasing,” he added.
— Julia Horowitz and Hanna Ziadi contributed to this article.
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