The good news is that there are still officials at the heart of UK decision-making who can recognise a financial crisis when it is staring them in the face. That’s not saying much, admittedly, but at least the Bank of England, having fiddled nervously all week, has emerged from its bunker. It will buy long-dated government gilts to quell the riot in the market that is most crucial in setting the long-term cost of borrowing in the economy.
The bad news is that the Bank’s hand was forced by the real danger of a calamity. Threadneedle Street does not use the phrase “a material risk to financial stability” lightly. Dysfunction was feeding on itself. Pension schemes were becoming forced sellers of gilts to top up their short-term capital buffers. They could not handle the spectacular blow-out in yields since Kwasi Kwarteng’s mini-budget last Friday. In a market where a daily move of a tenth of a percentage point is normally noteworthy, the yield on 30-year gilts had blown out from 3.6% to 5.1%. Yes, the Bank definitely had to act.
It is at this point, one hopes, that reality dawns on Tory MPs that the current crisis has very little to do with a strong dollar or global forces, or any of the other excuses that have been trotted out in recent days. The Bank had to intervene to save the government from the consequences of its own actions.
While forced selling by pension funds intensified the action, the deeper turmoil comes by markets’ brutal verdict on Liz Truss and Kwarteng’s £45bn package of tax cuts. It was investors – not the International Monetary Fund, say – who first judged that the chancellor’s plan is no way to manage the public finances when you are borrowing potentially huge sums to underwrite a blank-cheque guarantee on household energy bills for two years.
The supposed prize – an improvement to 2.5% in the UK’s growth rate – is years away, if it arrives at all. Meanwhile, inflation is 9.9% and the current account deficit, at 8%, is wide. Investors may tolerate a few economic unorthodoxies, but they’ll demand stiff terms to fund an economic gamble that simply looks reckless. That is the source of the surge in gilt yields. It flows from Downing Street.
So, too, does the incidental damage to the Bank’s own credibility, Only last week it was planning to sell gilts into the market – not buy them – under its quantitative tightening programme (or QT, the reversal of the easing programme of the last decade). Now QT has been delayed until the end of next month, which feels like a hope rather than an expectation. The Bank had no real choice in the matter, but confusion is unmistakable.
Meanwhile, dysfunction continues in the mortgage market as lenders yank fixed-interest offers. That part of the tale should also sound alarm bells on the backbenches. Panic over mortgage costs is now water-cooler and pub talk.
The way out of the mess must involve U-turns. Even after the Bank’s temporary yield-suppression operation, Kwarteng’s programme looks unaffordable. The size of the borrowing coming down the track is too large, and the risks to households’ and businesses’ borrowing costs are too great. Kwarteng pitched his plans as a way to avoid a deep recession, but the market’s reaction to his fiscal pyrotechnics has created the risk of a deeper one.
A couple of contenders for U-turns can be read from the IMF’s withering assessment. A minor tweak would reinstate the 45p income tax rate for high-earners as a signal of prudence. A bigger move would trim the energy support programme to six months and introduce a targeted scheme thereafter.
But if Kwarteng is determined to charge down his original track (he seems to be), he should hammer down his new fiscal rules and announce them soon. 23 November, the intended date, is too far away. The same goes for the Office for Budget Responsibility’s assessment of the state of the public finances. Let the budgetary watchdog bark.
A more dramatic U-turn lies in the hands of those same Tory MPs who must digest two hard facts. In the space of four trading days, a Tory “fiscal event” has led to a major intervention by the central bank to avert a “material risk” to financial stability and a run on pension funds. And none of this would have happened if Rishi Sunak had won the leadership contest. Kwarteng, surely, cannot survive another day like Wednesday.