The Bank of England has kickstarted a necessary series of British economic U-turns, writes Unmack1
Bank of England Governor Andrew Bailey speaks during the BoE’s financial stability report news conference, at the Bank of England, London, August 4, 2022. Yui Mok/Pool via REUTERS
LONDON, Sept 28 - The Bank of England has kickstarted a necessary series of British economic U-turns. UK Prime Minister Liz Truss’s plan to slash taxes has sent the pound and bond prices into a tailspin. The fallout makes it even harder for Governor Andrew Bailey to convince markets he can tighten monetary policy. Hison Wednesday to buy UK government debt and delay plans to sell down its 857 billion pound bond portfolio carries big risks. But it may make the necessary interest rate hikes easier.
Truss’s unfunded tax cuts, unveiled last Friday, started a riot in the debt market. The yield on 10-year UK government bonds had shot up by over a percentage point since last Friday as investors dumped UK assets amid fears of runaway spending and inflation. Bailey needs to persuade investors he will belatedly act to stem price rises. That means being willing to jack up interest rates, even at the expense of stalling economic growth and lifting borrowing costs for homeowners and companies.
The turmoil comes at a particularly bad time because, like the Federal Reserve, the BoE has been preparing to reverse its policy of quantitative easing. That involves shrinking the portfolio of bonds the central bank acquired during recent financial and economic crises. Bailey’s goal is to cut holdings by 80 billion pounds over the next year. This so-called quantitative tightening would require asset managers and investors to buy more bonds even as the government cranks up borrowing.
The BoE’s response to what it called “dysfunction” in the markets is therefore logical, and effective: bond yields dropped sharply after the announcement. But it comes at a cost. There’s a clear danger that the central bank appears to be subsidising the government whose wayward policies created the turmoil. Yet a more orderly bond market will also make it easier for the bank to wield its chief policy weapon of higher interest rates.
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