Some long-dated gilts have crashed more than bitcoin this year. UK 10-year borrowing costs are near those of Italy. A deeply unhelpful rift — more reminiscent of emerging markets than a G7 economy — is growing between ministers and the central bank over who caused turbulence in financial markets. In short order, Liz Truss’s government has presided over less Britannia Unchained — the book she and her chancellor, Kwasi Kwarteng, co-authored — and more Britannia Unhinged.
The Bank of England is in the invidious position of trying to clean up the mess left by Kwarteng’s unfunded “mini” Budget last month. He chose to announce the biggest tax cuts in 50 years when markets were already jittery about rising inflation and interest rates. There were bound to be consequences. But the BoE and its governor, Andrew Bailey, have not helped themselves. Through counter-productive and at times contradictory messaging this week, they risk making an already febrile situation worse, imperilling the very financial stability the central bank is meant to protect.
The world is watching. Fundamentals affecting the British economy even before Kwarteng’s hand grenade — steep energy costs caused by war in Ukraine, lockdowns’ lingering effects, and the end of free money and low interest rates — are common problems, as is the tension between monetary and fiscal policy. The IMF warned this week that the worst is yet to come.
Friday is set to mark the end of the BoE’s emergency gilt-buying operation, introduced two weeks ago to try to help pension funds, which were facing a liquidity crunch following turbulence exacerbated by the “mini” Budget. The BoE has since intervened twice more, introducing a new repurchase facility, and extending bond-buying to index-linked government debt for the first time. But the operations were little used before Wednesday (when the BoE bought £4.4bn of gilts) prompting questions about their design. Despite buying some initial calm, their effectiveness is also in doubt: gilts are again sustaining acute swings, with yields touching the level that first prompted intervention.
Pension funds have called for more time but Bailey has stressed that intervention is just temporary. No doubt trying to allay concerns over moral hazard, or that the BoE is attempting yield-curve control, he reminded the funds on Tuesday that they had just three days left, sparking even more market volatility. While the BoE has consistently stated that emergency measures would end on October 14, policymakers are said to have signalled to senior bankers in private that it may be more flexible.
It is possible, albeit tricky, to take a rigid public position and strike a more flexible tone in private, but Bailey has made life harder by underscoring the deadline — and Friday’s cliff-edge. The BoE already faced a dilemma by having to buy gilts to protect financial stability while promising to sell them to tame inflation. Bailey’s ultimatum leaves the BoE with less room for manoeuvre, and him with a credibility problem, should financial stability demand that it intervene once more.
The BoE did not cause the crisis. Its remedies are sticking plasters at most. Restoring confidence in the sustainability of UK finances will require a more substantive rowing back by the government from its promised tax cuts, particularly as Truss also rules out spending cuts. There are concerns over whether the BoE’s duties to protect both price and financial stability are in conflict. But as the 2008 financial crisis proved, clinging to such ideological purity is dangerous. As Truss’s government can testify — and the BoE must remember: credibility is hard won and easily lost.
