BBC Online :
The Bank of England has said it will step in to calm markets after the government’s tax-cutting plans sparked a fall in the pound and caused borrowing costs to surge.
It warned that if the market volatility continued there would be a “material risk to UK financial stability”.
The Bank will start buying government bonds at an “urgent pace” to help restore “orderly market conditions”.
The pound tumbled to $1.0586 after the news, down 1.4% against the dollar.
It comes after the currency hit a record low on Monday following the chancellor’s mini-budget, which pledged $45bn worth of tax cuts, funded by borrowing, as part of a plan to boost economic growth.
The government borrows money to fund its spending plans by selling bonds, or “gilts”, to investors such as pension funds and big banks on international markets.
The investor then gets to receive a stream of future payments, or “yield”, based on the interest rate the government has offered.
Due to concerns over whether the government’s plan will work, investors have been demanding much higher interest rates to lend to the UK government. But the Bank now hopes to lower these prices by buying its bonds.
The government’s long-term borrowing costs fell after the bank’s intervention on Wednesday, although still remains high.
The Bank of England was forced to intervene after the market turmoil heaped huge pressure on pension funds, which are required to invest in government bonds because they are usually so stable.
So called Liability Driven Investment funds – which support defined benefit pensions schemes – were facing a collapse in the value of the bonds they hold, which in turn could have forced them to rush to sell other assets, sparking yet more market panic.
The Bank has already said it will “not hesitate” to hike interest rates to try and protect the pound and try and stem surging prices. Some economists have predicted the Bank of England will raise the interest rate from the current 2.25% to 5.8% by next spring.
The projection has led hundreds of mortgage products to be taken off the market. There are also concerns the market turmoil could hit pension funds which often invest in government bonds.
