Pound falls and bonds under pressure as Liz Truss U-turns and Bank of England stops stimulus
The pound and UK bonds have come under further pressure as markets reacted negatively despite Lizz Truss's corporation tax U-turn.
The government had a turbulent day after Kwasi Kwarteng was forced to leave his role after just 38 days in the job.
Trading in the pound and gilts (UK government bonds) became more positive early on Friday after reports that parts of the government’s mini-budget announcement would be scrapped.
Sterling had pared back some of its early losses after the chancellor’s exit was confirmed.
But the pound fell back 1.2% against the dollar after a brief press conference where Ms Truss announced the reversal of the planned cut to corporation tax as the only major change to fiscal policy.
This means corporation tax will now be 25%, not 19%.
Meanwhile, the update also sparked another jump in gilt yields.
The interest rate on 30-year UK government bonds increased by 0.13% to 4.7%, representing an increase in the cost of state borrowing.
Gilts had seen their interest rates surge as high as 5.1% after the chancellor’s mini-budget was announced in September.
What do words like gilt and bond mean?
What is a gilt?
What is a gilt?
Gilts are essentially loans given to the government, also known as government bonds.
The government sells gilts to raise money for their spending plans. In return, investors who buy these gilts are paid interest each year until it is time for the government to repay investors in full.
For example, if an investor buys a gilt for £100,000 at an agreed rate of interest of, say, 5% over ten years, then the investor will get 5% of £100,000 (which amounts to £5,000) each year (or over another agreed period of time) until it is time for the government to give back £100,000.
The deadline for the government to repay is known as the maturity rate.
What is a bond? And what is a yield?
What is a bond? And what is a yield?
The yield of a bond is, simply put, the amount of money an investor receives for buying that bond.
Bonds are loans to the government – also known as gilts, as explained above – and the money the investor makes from the bond depends on the yield.
The yield is essentially the interest paid for the bond.
If an investor loans the government £100,000, this amount will be paid back in full at an agreed date in the future. In the meantime, the investor is paid interest on that loan at an agreed rate.
For example, if the interest is 2% then the investor would be paid £2,000 at the end of each agreed period – which could be a year. This is what the bond yield is.
Higher bond yields may indicate investors are reluctant to buy bonds.
What is inflation?
What is inflation?
Inflation represents the change in price level over a year.
Each month, the Office for National Statistics checks the prices of a range of items in a ‘basket’ of goods and services.
They look at the cost of more than 700 things people regularly buy, including everyday things like a loaf of bread and a bus ticket and larger ones, like a car or holiday.
To calculate the rate of inflation, they compare the cost of the basket with what it was a year ago. The change in the price level over the year is the rate of inflation.
The fallout after the mini-budget made an already-difficult fiscal situation for the government worse and engulfed Ms Truss's new government in crisis just a few weeks into the job.This caused the Bank of England (BoE) to step in to calm the gilt markets by promising to buy up to £65 billion in gilts from those who want to sell them.
Pressure to gilts returned on Tuesday after traders were spooked by Bank of England governor Andrew Bailey’s firm message that the central bank’s bond-buying scheme would not be extended beyond Friday.
However, an increase in gilt purchases by the BoE towards the end of this week and rumours regarding government policy reversals helped prices recover.
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The BoE bought around £4.7 billion of gilts on Thursday in an increased effort to help soothe the markets.
They bought just £1.5bn on Friday as they brought the programme to an end.
From the £65bn initially planned, the BoE only ended up buying £19.3bn.