Markets react negatively to Truss speech despite positive response to government U-turn on mini-budget
The Bank of England’s emergency intervention in UK government bonds is to conclude this afternoon with interest rates on the bonds down as a government change of tack is expected.
The financial markets have responded positively to the government’s anticipated U-turn on parts of its massive mini-budget programme of unfunded tax cuts and energy price cap spending.
Markets had already priced in the government’s policy U-turn as the interest rate payments on long-dated government bonds, effectively state IOUs, sunk on Friday morning while the pound rose against the dollar and the euro.
As a result of the government’s rise in corporation tax, instead of the reduction it announced in the mini-budget, government bonds, known as gilts, fell. The measure is expected to add £18bn to state coffers.
These are the bonds that have had to be bought up as part of the Bank of England’s unprecedented intervention in the market to prevent a collapse in pensions as the market doubted the credibility of the UK’s economic plans.
The interest rate on long-dated gilts, which is the effective cost of government borrowing, fell steeply on Friday.
The interest rates had risen sharply following the mini-budget announcement, causing a massive sell-off, before the Bank announced its 13-day intervention on 28 September. That intervention is to end on Friday afternoon.
The 30-year gilts fell from near a high of 5% on Thursday following Sky News’s announcement of the U-turn, to 4.3% on Friday.
Similarly 20-year gilts fell from near a high of 5% to 4.42%.
The fall in the interest rate of the benchmark 10-year government gilt was also large, from 4.3% on Thursday to slightly above 4% on Friday.
The pound also saw a rise against the dollar, up from $1.11 on Thursday to $1.13 on Friday morning, before settling at around $1.12 on Friday afternoon, despite a dip in the wake of the sacking of Kwasi Kwarteng.
Markets are now also betting the Bank of England’s base interest rate, which determines the cost of borrowing in the UK, is going to be lower than had been expected earlier this week. A rate of 5.25% is now forecast, the lowest rate forecast since the money budget and a large drop from the 5.75% that was priced by UK money markets on Thursday.
That reduction is likely to reduce mortgage rates which had steadily risen since the mini-budget announcement as lenders pulled mortgage products from the market amid uncertainty over how much the Bank of England would raise rates.
On Friday morning there were 3,112 mortgage products on the market, still lower than before the mini-budget was announced, but an increase from the ten year low of 2,258 mortgages available on 1 October.
Mortgage rates had risen significantly since the mini-budget date on 23 September. On Friday the average interest rate on a two-year fixed term mortgage was 6.47%, and 6.29% on a five-year fixed term mortgage was. It’s nearly a 2% increase from the 4.74% and 4.75% average rates for two and five-year fixed term mortgages that existed prior to the mini-budget.