The Bank of England intervenes to ensure financial stability, and the relationship with the government is further strained

The Bank of England is intervening to ensure ‘financial stability’ in the UK. The Bank of England will buy government bonds “temporarily” to prevent interest rates on those loans from skyrocketing. The bank announced this in a press release on Wednesday.

Financial markets have remained unstable since Prime Minister Liz Truss’s new government announced budget plans on Friday. Finance Minister Kwasi Quarting announced tax cuts worth 45 billion pounds (50 billion euros). It was previously announced that £150 billion of measures are being taken to reduce energy costs for homes and businesses. Investors fear that these measures are unsustainable and are fueling inflation.

The exchange rate of the British pound has fallen. Soon after Truss was elected by her party, the British currency peaked at $1.17 a pound. On Wednesday afternoon, it was just under $1.07 a pound – a drop of nearly 10 percent in a short period of time, and it’s a big move for the currency markets.

Attention went to the “Italian level”

The second effect of the budget plans: UK government bond yields rose from around 3 per cent in early September for 10-year government bonds to just over 4.5 per cent on Wednesday morning – a level close to those of Italy and Greece, the weak countries in the eurozone.

The Bank of England will now “temporarily” buy UK government bonds, according to its statement, in order to lower interest rates. It will do so “to the extent that will be necessary,” according to the central bank. After the Bank of England’s announcement, interest on British government bonds fell immediately to more than 4.1% on Wednesday.

Severe problems for pension funds due to lower bond prices

In its statement, the Bank of England spoke of “a material risk to the financial stability of the UK”. Rising interest rates on British debt securities have caused severe problems for pension funds in recent days, according to British media, which have seen the value of their bond investments plummet. So they had to start selling government bonds – causing a further drop in their value.

Read also: The depreciation of the British pound marks a new stage in the long-term peak of inflation

The central bank was about to sell 80 billion pounds of bonds. Because in order to tackle UK inflation, higher interest rates are really needed. Inflation in the UK (9.9% in August) has been an issue for longer than in the eurozone, and is more entrenched, in part because Brexit has sent import prices higher.

The bank is now released from the mission

The central bank has been put in a very difficult position by the government. The reckless fiscal policy of Truss and Quarting has distracted the Bank of England from its task of curbing inflation. This, ironically, while the Kwarteng package was supposed to contain inflation by regulating energy prices. British fiscal policy is now working against British monetary policy.

The relationship between Truss and the central bank led by Andrew Bailey has already soured recently. The Bank of England, like other western central banks, is independent. But during her campaign for prime minister, Truss couldn’t help but criticize the Bank of England. It looked like a central bank somewhat blameworthy from high inflation. By maintaining the pressure of money (by buying bonds), the central bank would have raised the price level. Truss is hardly prime minister – and she’s forcing the Bank of England to do just that: turn on the money press, if only temporarily.

Criticism from the International Monetary Fund

It does little good for the UK’s reputation. On Tuesday, the International Monetary Fund sharply criticized Britain’s budget plans. According to the fund, Truss management should “reconsider”. Truss and Quarting did not respond to the IMF statement or the Bank of England’s emergency measures.

It remains to be seen if the BoE’s decisions will be sufficient to restore calm to the markets. Although the central bank was able to stem the rise in government bond yields on Wednesday afternoon, the pound actually fell, only to bounce back afterwards.

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