Andrew Bailey was arriving at a meeting in Washington on Thursday as reports filtered out that the British government was preparing what could prove to be the mother of all U-turns.
Asked by reporters whether dropping plans for a large package of unfunded tax cuts would end weeks of turmoil in UK markets, the Bank of England governor refused to comment but he smiled broadly. When Chancellor of the Exchequer Kwasi Kwarteng dashed back to London hours later to deal with the mounting crisis, the reason for Mr Bailey’s satisfaction was clear.
Senior UK officials in Washington could not recall the last time a chancellor had left early from the International Monetary Fund’s (IMF’s) meeting but it was clear Mr Kwarteng’s budget was unravelling and he had no choice.
Two days earlier, 63-year-old Mr Bailey had found himself in the eye of the storm after vowing to end the central bank’s £65 billion (€75.2 billion) emergency bond-buying facility on Friday as planned.
Traders had expected an extension and responded by dumping the pound and pushing up the yield on UK government debt. Kwarteng warned that it would be “a matter for the governor if the rout extended into next week”. Analysts predicted that Bailey would be forced to reverse course, suffering a damaging blow to his credibility as a result.
And yet Mr Bailey’s gamble appears to be paying off, at least for the time being.
Markets rallied on the reports of U-turns on corporation tax and other parts of Mr Kwarteng’s so-called mini-budget. The pound closed 2 per cent higher versus the dollar on Thursday and was little changed on Friday morning. Government borrowing costs, which influence the mortgage costs of UK homeowners, fell as Mr Kwarteng was preparing for a hasty exit from Washington.
“It looks like Bailey’s pressure on the politicians may have worked,” said Tim Graf, head of EMEA macro strategy at State Street. “There is very little chance of purchases being extended.
For all Mr Kwarteng’s bravado, officials formed a protective barrier around Mr Bailey at the IMF meeting in the US capital, directing blame for the market turmoil squarely at the chancellor and UK Prime Minister Liz Truss. IMF Managing Director Kristalina Georgieva praised the BOE’s bond buying backstop, saying the “action was appropriate and had addressed “a risk to financial stability.
She also emphasised the need for “policy coherence and communicating clearly, a thinly veiled criticism of Ms Truss and Mr Kwarteng’s plan for £45 billion of unfunded tax cuts, announced three weeks ago without oversight of the independent Office for Budget Responsibility, which had unleashed the turmoil in UK markets.
While the market pressure has abated for now, there is still a significant risk that the government fails to deliver the increase in corporation tax or other measures that markets are now pricing in before trading opens next week.
“Some substantive follow through will be necessary if we have any hope of calmer conditions prevailing, said Richard McGuire a strategist at Rabobank in London.
Following Thursday’s rally in gilts and sterling, and with no BOE bond buying backstop from Monday, investors fear markets may suffer another shock if there are no solid policy announcements on tax and spending. — Bloomberg
