Emergency Bank of England intervention tempers sterling’s nosedive, UK changes course on tax cuts

Bank of England changes tack, forced to intervene as the pound tumbles below $1.04

Last week, the embattled British pound spooked markets further after it depreciated below $1.04 for the first time since 1985. The move, underpinned by a looming financial and economic crisis brewing within the United Kingdom, was largely precipitated by growing concerns from investors that the U.K. government’s implementation of sweeping tax cuts and investment incentives to boost growth would raise the national debt to unsustainable levels, ultimately prompting a frenzied sell-off of GBP-backed assets.

In response, the Bank of England launched emergency intervention measures by buying long-dated gilts “on whatever scale is necessary” to stabilize the currency and restore order to turbulent markets. Critically, this represents an abrupt change of policy and “monetary U-Turn” from the BoE’s battle to slow runaway inflation throughout the second largest economy in Europe. This morning, the U.K. government also changed its tune as finance minister Kwarteng announced the government would be reversing its pledge of sweeping tax cuts for Britain’s top earners.

While the pound has since rebounded from last week’s bottom — now trading at $1.12 due largely to the central bank's temporary stimulus and fiscal policy backtracking — markets have squarely priced in nearly 160 bps of rate hikes by the Bank’s November meeting. Over the coming weeks and months, investors and global corporates alike, particularly those with significant exposure to British assets and cash flows, will closely monitor the growing struggle between the U.K. government’s stimulus package, inclusive of massive tax cuts totaling £45 billion by 2027, and the central bank’s mandate to quell near-record inflation in the midst of an impending economic crisis.

European inflation reaches 10% for the first time, energy supplies nearing capacity

On the European continent, rampant inflation levels hit record highs, easily surpassing market estimates of 9.7%. The move marks the fifth consecutive month of increasing price pressures across the Eurozone. Year-over-year increases in energy prices clocked in at 40.8% vs. 38.6% estimates. Germany, the largest economy within the EU, recorded a staggering 10.9% inflation rate (vs. 8.8% estimate), followed by Italy (9.5% actual vs. 9.1% estimate).

The data comes as Europe braces for what could be a grim winter, as nations across the bloc race to fill natural gas and oil stores to prepare for widely anticipated supply shortages. As of September 28, energy storage facilities in Germany were 91.3% full, higher than the European average of 88.3% and much greater than usual for this time of year.

U.S. 10Y yields top 4% amid continued Fed hawkishness

In the U.S., 10Y bond yields briefly top 4% for the first time since 2010. Investors continued to brace for hardline hawkishness from the Federal Reserve as global market turmoil prompted several Fed speeches last week to confirm the central bank’s commitment to fighting inflation, even at the risk of propelling the U.S. economy into a deep recession.

Last week, policymakers also cut outlooks for 2022 economic growth throughout the United States, adjusting expectations to just 0.2% year-over-year growth in annual U.S. GDP, adjusted down from June’s 1.7% expectation. Markets currently anticipate the Fed’s terminal federal funds rate to peak at 4.6%, with rate cuts expected to begin in 2024 and extend into 2025.

The week ahead

This week, markets will closely monitor global debt and currency markets for signs of continued turmoil. In the U.S., investors will continue to assess Hurricane Ian’s impact on supply chains, commodity pipelines, and energy grids throughout the southeast.

On the economic data front, initial jobless claims will be released on Thursday and a critical September Nonfarm payrolls report will be released Friday.