The Bank of England said it will buy long-dated British government bonds to “whatever scale is necessary” in order to restore orderly market conditions.
The move was announced Wednesday after two days of turmoil, which featured the British pound crashing to a record low against the United States dollar and the yield on U.K. government bonds soaring. The rout began after the British government announced plans to slash taxes and borrow money to cover the costs.
“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,” the Bank of England said in a statement.
In the statement, the central bank acknowledged that its purchase of the “gilts,” the phrase used to describe U.K. government bonds, will be “strictly time limited.”
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“They are intended to tackle a specific problem in the long-dated government bond market. Auctions will take place from today until 14 October,” said the Bank of England. “The purchases will be unwound in a smooth and orderly fashion once risks to market functioning are judged to have subsided.”
The problems began after the government’s announcement of the unfunded tax cuts. While the newly sworn-in government, led by Conservative Prime Minister Liz Truss, envisioned the cuts spurring economic activity, investors and economists quickly worried that the move would undercut the Bank of England’s goal of tamping down inflation.
The United Kingdom is facing some of the worst inflation in the world, with price growth clocking in at about 10% for the 12 months ending in August. Central banks work to slow inflation by dampening demand, so the move to put more money into the hands of consumers was seen by some as contradictory.
“So you have a world where you have a recession and the BOE is trying to cool the economy with hikes, and on the other hand, you have the Treasury that is trying to shield the economy from that recession and implementing fiscal measures that are inflationary,” Antoine Bouvet, an ING senior rates strategist, told CNBC.
The pound plummeted by around 5% on Monday to a record low of $1.03 during trading in Australia and Asia before pulling back some of those losses when European markets opened later on Monday. On Wednesday, the pound was trading as low as $1.05, although it popped a bit to an also-very-low $1.07.
For reference, a year ago, the pound was above $1.35 against the greenback and above $1.15 at the start of September.
Yields on U.K. government bonds have exploded in the past couple of months. The yield on the 10-year gilt was at 4.114% on Wednesday — up from 1.813% at the start of August, a massive increase.
There is concern that the situation with the strength of the British currency could worsen, with some top economists and financial analysts predicting that the pound will reach parity with the dollar in the coming months or even plunge below that level.
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Not helping the situation is that, apart from U.K. fiscal policy, the U.S. dollar has been surging as the Federal Reserve has tightened monetary policy.
Since the start of March, right before the Fed started increasing its interest rate targets, the dollar, as measured by the dollar index, has risen by more than 15%. The value has increased by more than 18% since the start of the year.
