Gilts and sterling rallied on Monday after Jeremy Hunt, the new UK chancellor, took a wrecking ball to his predecessor Kwasi Kwarteng’s controversial tax-cutting plans in an effort to mollify financial markets.
The 30-year gilt yield tumbled 0.41 percentage points to 4.37 per cent, reflecting higher prices. The moves reversed the majority of a surge late on Friday after investors decided prime minister Liz Truss had not gone far enough by sacking Kwarteng and ditching an £18 billion corporation tax cut.
Thirty-year government borrowing costs remain far above the level of about 3.75 per cent seen before last month’s £45 billion (€52 billion) of unfunded tax cuts sent markets into a tailspin and triggered a liquidity crisis for UK pension funds. Shorter-dated gilt yields also fell sharply, while the pound gained 2.2 per cent against the dollar to trade at $1.1418.
In a statement on Monday, Hunt confirmed that he was scrapping £32 billion of those cuts, and scaling back energy subsidies offered by last month’s “mini” budget. The pound and UK government bonds extended their gains as he spoke.
Gilt selling had reignited late on Friday as the Bank of England’s (BoE) emergency market intervention came to an end, with the central bank having purchased just £19 billion of a potential £65 billion of long-dated bonds.
The BoE reiterated on Monday that the programme had finished but that a new short-term lending facility unveiled last week to help ease liquidity pressures at pension funds would continue until November 10.
Monday’s announcement from Hunt should ease the pressure on the BoE to intervene further in markets, said Antoine Bouvet, a rates strategist at ING.
“This is all very positive for markets,” Bouvet said. “It’s not just the numbers, but the fact he’s done away with the unapologetic tone and underlined that the government is listening to markets.
“But ultimately you have to remember that market confidence has been shattered, and it’s going to take some time to rebuild.”
Despite the fall in yields, pension funds said they were continuing to sell gilts in order to replenish their cash buffers.
“It was a bit calmer this morning, but the selling has not abated,” said Mike Eakins, chief investment officer of Phoenix, the £270 billion manager which serves 13 million customers. “We are still seeing funds having to sell their gilts and we think there’s more to run on that.”
The bond rally came as traders dialled back their bets on aggressive interest rate increases from the BoE. Markets had in recent weeks been bracing for rates to soar above 6 per cent by May next year as the central bank tried to offset the inflationary implications of Kwarteng’s borrowing plans and to bolster a tumbling pound. Futures markets are now pricing in a peak of rates at just under 5.25 per cent in May.
Hunt’s change of tack “may well have done enough to prevent a formal downgrade” to the UK’s credit rating later this week, according to Investec economist Philip Shaw. Rating agencies S&P and Moody’s have both said the “mini” budget was negative for the country’s creditworthiness ahead of scheduled ratings reviews on Friday.
“The new chancellor has attempted to restore credibility to UK fiscal policy and his prompt intervention illustrates how seriously he is taking it,” Shaw said.
The latest government U-turn follows growing calls from Conservative MPs and business figures for Truss’s resignation over the weekend, with a number of cabinet ministers seeking to drum up support for potential leadership contenders.
— Copyright The Financial Times Limited 2022
