UK Treasury, central bank fail to calm sterling crisis

Attempts by the UK central bank and Treasury on Monday to steady the pound failed to reassure markets — as sterling fell to record lows and gilt yields soared again.

The fall in UK gilts sent 10-year yields above 4% for the first time since 2010 as traders made big bets on the size of UK interest rate hikes.

Bank of England governor Andrew Bailey said in a statement the central bank is “monitoring developments in financial markets very closely” and that it “will not hesitate to change interest rates by as much as needed to return inflation to the 2% target sustainably in the medium term, in line with its remit.”

The pound fell after the statement and was down 1.8% at $1.0663 in late afternoon trading.

Sterling’s latest woes started on Friday following the unveiling of new finance minister Kwasi Kwarteng’s massive tax cuts — funded by the biggest increase in government borrowing since 1972 — panicked markets.

“The UK is now in the midst of a currency crisis,” said Vasileios Gkionakis, EMEA head of foreign exchange strategy at Citigroup.

Victoria Scholar, head of investment at Interactive Investor said: “The central bank has decided to hold off from an emergency rate hike, instead opting for an attempt at verbal intervention instead.

“However the statement, which was designed to stem further losses for sterling, did in fact the exact opposite.

“Currency traders sold the pound following the release amid a sense of disappointment that more aggressive action wasn’t taken.

“It looks like an emergency rate hike is off the table at least for now with the Bank of England aiming to raise interest rates in five weeks’ time at its next meeting on 3rd November.

“Last week the Bank of England opted for a relatively dovish 50 basis point hike versus some forecasts for a 75 basis point jump.

“In light of the Chancellor’s mini-budget and the consequent fallout for the pound, arguably that was a mistake.

“The Bank of England should have opted for the more hawkish approach to combat inflation with the UK economy poised for further upward price pressures following sterling’s slump.

“The pound’s slide will add to the UK’s inflationary backdrop by making UK imports from abroad more expensive, in turn raising domestic price levels.

“It looks increasingly likely that the pound is heading towards parity against the greenback with some forecasters even suggesting it could push below $1 in the months ahead.”

Derek Holt, head of capital markets economics at Scotiabank, told Reuters: “UK markets are blowing up again in the wake of the Truss administration’s tone-deaf fiscal largesse that was delivered on Friday into a bond market that loathes any steps that fan inflation risk and higher debt issuance.

“How could the admin and its political wonks have so seriously misjudged the reaction to spending hundreds of billions of pounds,” he said.

Paul Dales, chief UK economist at Capital Economics, said: “The initial reaction in the markets, with the pound falling again after it regained some ground, suggests that the issue may not be put to bed yet.

“Either way, the end result will probably be interest rates rising sooner and further (perhaps from 2.25% to 5.00%) in the coming months.”

The Treasury said in a statement that the UK government will announce further supply side growth measures in October and early November.

Bank of England governor Andrew Bailey said: “The bank is monitoring developments in financial markets very closely in light of the significant repricing of financial assets.

“In recent weeks, the Government has made a number of important announcements.

“The Government’s Energy Price Guarantee will reduce the near-term peak in inflation.

“Last Friday the Government announced its Growth Plan, on which the Chancellor has provided further detail in his statement today.

“I welcome the Government’s commitment to sustainable economic growth, and to the role of the Office for Budget Responsibility in its assessment of prospects for the economy and public finances.

“The role of monetary policy is to ensure that demand does not get ahead of supply in a way that leads to more inflation over the medium term.

“As the MPC has made clear, it will make a full assessment at its next scheduled meeting of the impact on demand and inflation from the Government’s announcements, and the fall in sterling, and act accordingly.

“The MPC will not hesitate to change interest rates by as much as needed to return inflation to the 2% target sustainably in the medium term, in line with its remit.”

The UK Treasury said in a statement: “On Friday 23 September, the Chancellor of the Exchequer, the Rt Hon Kwasi Kwarteng MP, set out how the government would fulfil its commitment to cut taxes for people and businesses and announced wider supply side policies to grow the economy.

“Building on this, as the Growth Plan set out on Friday, Cabinet Ministers will announce further supply side growth measures in October and early November, including changes to the planning system, business regulations, childcare, immigration, agricultural productivity, and digital infrastructure.

“Next month, the Chancellor will, as part of that programme, outline regulatory reforms to ensure the UK’s financial services sector remains globally competitive.

“He will then set out his Medium-Term Fiscal Plan on 23 November.

“The Fiscal Plan will set out further details on the government’s fiscal rules, including ensuring that debt falls as a share of GDP in the medium term.

“In the Growth Plan on Friday, the Chancellor set out that there would be an Office for Budget Responsibility forecast this calendar year.

“He has requested that the OBR sets out a full forecast alongside the Fiscal Plan, on 23 November.

“As the Chief Secretary to the Treasury set out this weekend, the government is sticking to spending settlements for this spending review period.

“The Chancellor also confirmed that there will be a Budget in the Spring, with a further OBR forecast.”

Alastair George, chief investment strategist at Edison Group, said: “Today’s Bank of England and UK government statements can at best be described as too little, too late.

“There is no rate increase today and speculators will enjoy the prospect of two months of Bank of England inactivity if the statement is taken at face value.

“The pro-cyclical mini-budget is seen as counter-intuitive to international investors in the UK who must be wondering if politicians understand the ramifications of policies which have triggered a meaningful sterling crisis.

“Gilt yields and interest rate futures have jumped 1% since only Friday as traders expect the Bank of England to ultimately be forced to act to defend the currency – and at the expense of braking the domestic economy hard.

“We fear this is will not be an easy situation to stabilise – monetary policymakers need to act decisively head off speculative attacks on the currency, separately from the relative merits or otherwise of the recently announced fiscal measures.”