There was drama this week as Andrew Bailey, governor of the Bank of England, doubled down on the Bank’s commitment to ending support for Britain’s pension funds by tomorrow (14 October). “We will be out by the end of the week,” he warned a gathering of the International Monetary Fund in Washington on Tuesday (11 October). The funds would have just “three days” left to restructure their operations and get out of the positions that had brought at least some to the brink of insolvency following Kwasi Kwarteng’s mini-Budget barely three weeks ago.
The market reaction was immediate, the government’s borrowing rate instantly shooting upwards as traders processed the full import of Bailey’s comments.
The Bank had promised to buy up to £5bn a day of long-dated UK government bonds, those maturing over 30 years, on the Wednesday after the mini-Budget. By offering to buy UK government bonds, the Bank of England was promising to stabilise the market. It’s fundamental to any central bank that it will do something like this. Central banks only exist because, as modern banking developed, there was a need to find some institution that could step in and bail out a failed bank, protecting the system as a whole.
Yet the promise to buy bonds was time-limited – setting up exactly the kind of panic we’ve seen over the last week, as traders feared the consequences of the Bank withdrawing support. Reports the following day that the Bank would still offer support to stricken pension funds, and the announcement, by the Bank, of a smaller scheme to run beyond the 14 October, seemingly did little to calm nerves.
It looked like another instance of Bailey’s foot being planted firmly in his mouth, akin to his suggestion that to deal with inflation some “wage restraint” might be required from those not on his £500,000-a-year salary. Fundamentally, the Bank is in a contradictory position: its efforts to act as a guarantor of financial stability have meant it has needed to buy government bonds, directly counter to its own plan to sell government bonds in an effort to meet its inflation target. Attempting to square this particular circle would try even the most silvery-tongued of central bankers.
Bailey’s suggestion of ending the Bank’s assistance was certainly a threat to pension funds and others, but the chaos that erupted was perhaps an even bigger warning to government: that the Bank really can summon up market terror if it wishes. What we saw this week would be only a harbinger of what might happen after the weekend if the government doesn’t change course.
News today of a potential U-turn on further parts of the mini-Budget, and the subsequent rally in the pound, suggests the Bank may have won. A reversal of some planned tax cuts seems likely – and perhaps with them, the end of Kwarteng’s time in No 11. But for a country to find its central bank playing chicken with its own government is surely a sign of a far deeper malaise. The outlook for the world economy is bleak and worsening; Britain’s dysfunctional institutions look barely able to cope.