Bank Of England Quells Market Chaos After U.K. Government Spooks Investors

Topline

The Bank of England took steps to calm roiling markets on Wednesday as leading financial institutions continue to castigate the British government for tax cuts they claim could worsen inequality and hamper economic growth, a move that immediately soothed bond markets but did little to prevent the pound sliding back towards the historic low it sank to last week.

Key Facts

U.K. government bonds rallied on Wednesday after the Bank of England committed to buying long-term bonds and “restore orderly market conditions,” which were whipped into a frenzy last week when treasury chief Kwasi Kwarteng announced plans to borrow billions in order to scrap the highest rate of income tax and support households with rising energy costs.

The move did little to arrest the pound’s decline against the dollar, which dropped below $1.055 after briefly rallying, down 1.7% on the day and edging towards the record low of $1.035 it sank to on Monday.

The intervention follows harsh critique from the IMF, an international organization with 190 member countries that works to stabilize the global economy, which warned plans for large unfunded tax cuts and huge increases in public borrowing could stoke inflation and deepen inequality.

The organization said it is “closely monitoring” developments in the U.K. and urged the government to “re-evaluate” its policies, particularly those that “benefit high-income earners.”

The IMF, which rarely criticizes a developed economy publicly, is not alone in expressing concern over Britain’s fiscal policies, and influential credit agency Moody’s warned the policies could slow the country’s economic growth and “permanently weaken” the country’s ability to afford debt.

Moody’s raised the prospect of downgrading the U.K.’s credit rating in the future and slashed GDP growth forecast for 2023 from 0.9% to 0.3%.

Contra

The treasury backed its policies in a statement issued after the Bank of England’s surprise intervention on Wednesday. Despite rising panic among investors and stinging rebuke from financial institutions like the IMF, the treasury blamed “significant volatility” in global financial markets for the collapse in confidence, not Kwarteng’s unfunded fiscal policies.

News Peg

Kwarteng, who was tasked to lead the treasury by newly-installed Prime Minister Liz Truss, announced a new economic strategy that included sweeping tax cuts—which notably benefit the better off more and removed the higher rate of income tax—cut caps on bankers’ bonuses and plans to control soaring energy costs. It spooked investors and triggered a market meltdown, prompting the Bank of England to raise the prospect of drastic interest rate hikes to regain control.

What We Don’t Know

The impact of the U.K.’s economic plans. Truss vowed a swift “emergency budget” to address soaring inflation and the cost of living crisis upon entering Downing Street earlier this month. However, the plans—one of the biggest packages of tax cuts in decades—were later classified as a “fiscal event” and came without the usual economic forecasts that accompany budgets. Truss has been criticized for this and accused of using another term to avoid scrutiny. A full forecast will be expected alongside the next budget in late November.

Further Reading

Pound Plummets To Record Low Against U.S. Dollar After U.K. Signals More Tax Cuts (Forbes)

Is Britain now in a full-blown economic crisis? (Financial Times)

IMF: What is it and why does it matter? (BBC)