Bank warns of bumper rate hike after market rout

The government’s long-term borrowing cost hit its highest level in 20 years yesterday as the Bank of England paved the way for a steep rate hike within weeks.

The bank’s chief economist, Huw Pill, said a “major policy response” was needed after Kwasi Kwarteng’s mini-budget and subsequent market turmoil.

Yields on 30-year British bonds, known as gilts, rose by more than 5 percent to their highest level since 2002 – just 2.9 percent a month ago.

Yields on 20-year gilts have also risen sharply, while benchmark 10-year gilts are on track for their worst month since 1957.

That makes it more expensive for the government, companies and households to borrow.

But the pound stabilized after its dramatic fall to an all-time low below $1.04 early this week. Government bond yields have been rising for weeks and sterling has been falling amid fears about the global economic outlook.

The sell-off accelerated on Friday after the chancellor unveiled tax cuts worth £45bn, the largest in half a century, in a bid to boost growth.

Markets were shocked by the size of the loans needed to finance the austerity measures and a £100bn package in utility bills helped.

The sell-off continued into early Monday, when the pound fell to its record low against the dollar.

Sterling has climbed from that low but struggled to gain ground yesterday, falling just below $1.07.

The Bank’s initial response on Monday, in which Governor Andrew Bailey said he would not hesitate to raise interest rates if necessary, failed to recover the pound.

Yesterday, Pill said the “combination of tax announcements” in the mini-Budget would act “as a demand boost.”

He added: “I think it’s hard not to conclude that all this requires a major monetary policy response.”

However, the Bank is resisting calls for an emergency meeting and an interest rate hike before the next meeting on November 3. The interest rate, now 2.25 percent, is expected to exceed 6 percent next year.

Some market observers believe the Bank’s lack of action in tackling inflation is largely responsible for creating sharp market conditions before the dam burst on Friday.

Other elements of the mini-budget were expected and Chris Teschmacher, of Legal and General Investment Management, said that “surprise elements…are actually not that expensive to fund.”

“The foreign exchange market reaction seems to be more about the Bank of England’s credibility in fighting inflation and fiscal control over the longer term,” he said.

Michael Brown, head of market intelligence at Caxton, said: ‘The Bank of England’s statement that they will ‘will not hesitate to change rates as much as necessary’ more than lived up to market expectations.

“It was an inadequate statement from an inept central bank that is way out of the depths; but admittedly, there are no easy options to get out of this mess.”

The government was still able to sell gilts yesterday, with a £1.2 billion auction covered 2.3 times. But real 2031 inflation-linked government bond yields were the highest since November 2012.