The deputy governor of the Bank of England has described the bond-market turmoil prompted by chancellor Kwasi Kwarteng’s mini budget as “unprecedented” and said “widespread financial instability” could have resulted without the bank’s emergency intervention.
Sir Jon Cunliffe said rising returns demanded for 30-year government bonds in the days following Kwarteng’s £45bn package of unfunded tax cuts, announced on 23 September, outstripped the “dash for cash” in the early days of the coronavirus pandemic twofold.
He added that, measured over four days, the impact was more than three times larger than any other historical move over the past two decades.
Cunliffe’s observations came in a letter to members of parliament’s Treasury Select Committee, who requested details of the bank’s £50bn emergency bond-buying package, which was announced on Wednesday last week.
The deputy governor said that if the emergency measures – agreed in advance with Kwarteng and HM Treasury– had not been implemented, multiple liability-driven investment pension funds would have fallen into negative equity and begun the process of winding up.
“In that eventuality, a large quantity of gilts, held as collateral by banks that had lent to these LDI funds, was likely to be sold on the market, driving a potentially self-reinforcing spiral and threatening severe disruption of core funding markets and consequent widespread financial instability,” he said.
Cunliffe added that the chain of anticipated events would likely have spread from LDI funds and caused “self-reinforcing falls” in asset prices.
“This would have resulted in even more severely disrupted core gilt market functioning, which in turn may have led to an excessive and sudden tightening of financing conditions for the real economy,” he said.
Despite the bank’s actions, one result of the shockwaves felt by financial markets has been a rapid repricing of mortgage products, with interest rates on two-year fixed deals returning to levels not seen since 2008.
On Monday, Kwarteng performed a screaming U-turn on one of the mini-budget’s flagship measures – abolition of the 45% top rate of income tax for the highest earners. The move came less than 24 hours after prime minister Liz Truss insisted she was committed to the hugely controversial measure.
Government ministers have repeatedly sought to frame the drop in the value of sterling against the US dollar and the euro that followed Kwarteng’s Growth Plan 2022 package of tax cuts as part of longer-term financial movement prompted by wider global recessionary fears.
Zahawi 'sorry' for mini-budget repercussions
Last night Cabinet Office minister Nadhim Zahawi – who served as chancellor for two months over the summer – was laughed at by audience members on BBC One’s Question Time panel show for attempting to frame mini-budget fallout against the backdrop of Russia’s invasion of Ukraine.
Harangued over the government’s failure to apologise for the impact of the mini-budget by fellow panellist Piers Morgan, Zahawi eventually said: “Of course I’m sorry. Absolutely.”
Cunliffe’s letter to Treasury committee chair Mel Stride contains a diagram clearly illustrating the rocketing yield sought on UK government 30-year bonds in the days between Kwarteng setting out his mini-budget and the unveiling of the Bank of England’s market-stabilising intervention.
While US 30-year gilts and EU area 30-year gilts saw yields rise by well under 50 basis points over the period, UK 30-year gilts soared by 150 basis points.
Although they dropped back significantly after the bank’s emergency intervention, the change in their value remained well ahead of US and EU counterparts.