The pound and long-term government debt dropped as jitters returned to UK financial markets on Wednesday, a week after the Bank of England’s dramatic intervention halted a chaotic sell-off.
Sterling fell by more than 2 per cent against the dollar to $1.123 as the dramatic rebound from last week’s all time low of $1.035 stalled. The moves, which partly reflected broad gains for the US currency, followed Liz Truss’s Tory party conference speech in which she sought to reassure markets by stating her commitment to fiscal discipline.
The latest declines come 12 days after the announcement of £45bn of unfunded tax cuts by Truss’s government sent the currency and the UK bond market into freefall.
“There wasn’t much detail on how they plan to be disciplined on the public finances,” said Geoffrey Yu, a market strategist at BNY Mellon. “That’s not great for credibility.”
UK government bonds were also hit with renewed declines, which accelerated after the BoE said it had declined to buy any bonds for the second day in a row under its programme introduced a week ago to prop up long-term debt in order to stave off a liquidity crisis in the pensions sector.
Thirty-year gilt yields, which rise as prices fall, climbed by as much as 0.26 percentage points to 4.33 per cent, their highest level since the aftermath of the BoE’s market intervention last Wednesday, before pulling back to 4.21 per cent.
Rohan Khanna, an interest rate strategist at UBS, said the moves were partly a result of confusion in markets about the kind of moves that are likely to provoke further BoE buying.
“We are learning something about it every day,” Khanna said. “[The BoE is] clearly of the opinion that the market is well behaved here, as it is selling off in tandem with other fixed income markets, and hence does not need any intervention.”
The BoE sought to clarify on Wednesday that the purpose of its purchases is to act as a backstop to restore orderly trading in markets, rather than a commitment to intervene at a specific level. “The Bank’s allocation methodology is not based on absolute price or yield, or the identity of the seller,” it said.
Wednesday’s moves further cement the tendency seen since last month’s “mini” Budget for sterling and gilts to rise and fall in unison, a reversal of the typical relationship in developed markets where higher borrowing costs typically buoy a currency.
Yu said the pattern, which is more typically seen in emerging markets, comes as investors bet that currency weakness — which bolsters inflation — will prompt swifter rate increases from the central bank.
“This is an important change in the UK’s foreign exchange regime,” he said. “Sterling will struggle to shift that.”