Despite the backtracking by Prime Minister Liz Truss of Britain, and the billions spent by the Bank of England to ease a liquidity crunch among pension funds, uncertainty returned to British bond markets on Friday afternoon.
That has left a feeling of nervousness about what will happen when markets reopen on Monday.
Even before Ms. Truss announced she was sacking her chancellor of the Exchequer and would U-turn on another major tax policy, Friday was a critical day in Britain’s financial markets.
It was the last day of the Bank of England’s two-and-a-half week intervention in Britain’s bond markets, buying government securities. The central bank jumped into the market in late September to prevent “fire sale dynamics” and financial instability after the government’s tax-cutting plan had roiled markets, sending bond yields and mortgage rates sharply higher and putting pension funds at risk.
But even as Ms. Truss was speaking, and as the central bank was buying its last government bonds under the program, bond yields were climbing.
Ms. Truss’s policy reversal, aimed at calming nerves jangled by billions in unfunded tax cuts, produced an almost “equal and opposite effect” because it signaled political instability, increasing speculation about how long she will last as prime minister, said Antoine Bouvet, an interest rates strategist at ING.
“The shape of successful government policy will be very difficult for the market to predict,” Mr. Bouvet said.
There is an element of fear in the market because of the “political instability coupled with the fact that the market is on its own — there is no Bank of England intervention anymore,” he said.
“I’m personally nervous and the market sentiment is nervous,” he added.
Earlier this week the pension fund industry lobbied the bank to extend the program designed to help resolve liquidity issues. But Andrew Bailey, the governor of the bank, was adamant that it would end on Friday, telling the industry: “You’ve got to get this done.”
There has been concern that once the central bank steps back out of the market, the volatility stirred up by the government’s Sept. 23 policy statement would return and bond yields would surge higher. Higher yields are already driving up the government’s borrowing costs, interest rate payments, and mortgage rates for households.
Speculation that the government would retreat on more of its tax cuts — costing £43 billion and funded by borrowing — helped markets rally in the middle of the week. But once Ms. Truss delivered the widely-expected U-turn and said she would not scrap a planned rise in corporation tax worth about £18 billion, yields climbed again.
The yield on 30-year bonds closed on Friday at 4.78 percent, about 0.2 percentage point higher than the day before. On Sept. 22, the day before the government unveiled its tax-cutting plan, the yield was 3.78 percent.
Despite Friday’s news, the sense that the central bank and the government are working at cross-purposes prevails. The government has committed to delivering an updated fiscal plan on Oct. 31, and for now more than half of the previously announced tax cuts are still in place, according to the Resolution Foundation, a London-based think tank.
On Nov. 3, the central bank will make its next interest-rate decision. The bank’s chief economist has previously said it will need to be “significant.”
At the same time, the central bank has been keen to avoid the impression that its bond-buying program is shielding the government from the market consequences of its actions. Analysts say this is one of the reasons its been firm about limiting the bond purchases to a short period of time, even if it’s a bit of a gamble that the pension funds will have resolved their liquidity issues in time.
It might not be clear until Monday if this gamble paid off.
