It is not often that a central bank tries to calm the financial markets two days in a row. But the Bank of England apparently had no choice but to intervene again. After the British central bank had already expanded its purchases of government bonds on Monday, she went one step further on Tuesday: She announced that in addition to long-dated government bonds, she would also buy government bonds that are linked to the inflation rate. And that’s not all. The central bank announced that the sale of corporate bonds would also be suspended for this week.
The reason for the extraordinary actions of the Bank of England are the economic policy plans of the new British government. Two weeks ago, it announced a massive tax cut package to boost growth. Yet the so-called “growth plan” triggered one thing above all: chaos on the financial markets.
The British pound depreciated dramatically against the US dollar. And the yields on long-dated British government bonds have soared so much that pension funds in particular, which invest their money for the long term, have come under pressure. About 70 percent of private pension fund assets are invested in bonds, according to the Pension Protection Fund. Deputy Prime Minister Therese Coffey said Tuesday after the Fed’s intervention that it was “absolutely confident” that people’s pensions were safe.
How Kwarteng intends to achieve 2.5 percent growth is unclear
The government did reverse the cut in the top tax rate, but that alone did not convince the markets. Because it is still unclear how Finance Minister Kwasi Kwarteng intends to finance the relief package – without public debt increasing massively. Kwarteng has not yet presented a plan on how the tax cuts are to be financed. He only speaks of the goal of achieving economic growth of 2.5 percent in the medium term. However, how this is to be achieved is his secret.
On Monday, Kwarteng announced that he would reveal this secret on October 31st. He actually didn’t want to present his financing plan until the end of November, but in view of the continuing turmoil on the markets, Kwarteng decided to bring the date forward by almost a month. From the markets’ perspective, this means one thing above all: it is still more than two weeks before it is clear how the government intends to finance its tax cuts.
According to calculations by the Institute for Fiscal Studies (IFS) think tank, Kwarteng will need to announce more than £60 billion in savings to convince markets that the tax cuts are adequately funded. In theory, Kwarteng could achieve this by cutting spending. But the question is where the finance minister can save at all. Spending on health care and defense is already falling because the government has announced that it will invest in both areas. The think tank is also extremely critical of Kwarteng’s growth target of 2.5 percent. This is doubtful in view of the global uncertainty resulting from the Russian attack on Ukraine.
Kwarteng is traveling to Washington this week with the head of the central bank, Andrew Bailey, for the meeting of the World Bank and the International Monetary Fund (IMF). Both will have to do some persuading there to calm the markets down again. The rating agency S&P recently lowered the outlook for British government debt from “stable” to “negative”. The agency Moody’s also expressed concerns. A worse rating usually means that the state has to pay higher interest rates to take on new debt. Kwarteng also has to take this into account in his calculations.