British government borrowing costs surged again today after Bank of England Governor Andrew Bailey told pension funds they had three days to fix liquidity problems before the bank ends emergency bond-buying that has provided support.
Twenty and 30-year gilt yields both hit their highest since 2002 at 5.195% and 5.1% respectively, passing above 5% for the first time since the BoE began buying bonds on Sept. 28 to calm turmoil triggered by Prime Minister Liz Truss's tax cut plans.
However the pound strengthened by 1%, recovering from a fall sustained late on Tuesday after Bailey delivered his blunt message on the sidelines of the International Monetary Fund meeting in Washington.
"We have announced that we will be out by the end of this week. We think the rebalancing must be done," Bailey said.
"My message to the funds involved and all the firms involved managing those funds: You've got three days left now. You've got to get this done."
British financial markets have been under strain since new finance minister Kwasi Kwarteng announced £45 billion of tax cuts on September 23 with no details of how to pay for them.
Kwarteng and Truss say the cuts are needed to get Britain's economy growing again. Data published on Wednesday suggested it was heading for recession.
Truss told parliament today that she had no intention of cutting public spending to fund the tax cuts and deputy finance minister Chris Philp said the government would not reverse the tax plans, aside from one income tax measure costing 2 billion pounds a year.
The surge in borrowing costs has hammered some pension funds, prompting the BoE to launch the bond-buying programme, the maximum daily size of which it doubled on Monday before extending it to include inflation-linked bonds on Tuesday.
Prices for index-linked gilts, which offer holders protection against inflation, rose modestly on Wednesday, avoiding the slump afflicting conventional gilts, which briefly pushed benchmark 10-year yields to their highest since 2008 at 4.632%.
Gilt yields determine borrowing costs for households and businesses as well as the government.
Investors are nervous that Friday's halt to the BoE's bond-buying might come too soon for some pension funds.
"Bailey has to give the message that the BoE is ready to walk away but fundamentally there has to be a big question mark over that and whether the BoE carries on, or whether financial stability risks continue and the BoE comes back to the market," Daiwa Capital Markets' head of economic research Chris Scicluna said.
The Financial Times reported that the BoE had privately suggested to bankers that it could carry on buying bonds beyond Friday's deadline if market conditions demanded it, citing three sources briefed on the discussions.
But a BoE spokesperson said it had been made "absolutely clear in contact with the banks at senior levels" that the Friday deadline would hold.
Kwarteng said the decision on when to end support - which is underwritten by the finance ministry - was one for Bailey.
The central bank said on Tuesday that the situation posed a "material risk" to financial stability.
On Wednesday, it said it was "closely monitoring" liability-driven investment (LDI) funds, which are key to pension funds, ahead of Friday's deadline.
Bailey and other BoE officials stress their bond-buying - at a time when they were supposed to be selling government bonds to wind down their huge economic stimulus - is temporary.
The BoE's chief economist, Huw Pill, stressed the need for the government to pursue a credible fiscal policy that did not undermine the BoE's attempts to rein in inflation, which is near a 40-year high at 9.9%.
A "significant" move in monetary policy was likely to be necessary on Nov. 3, after the BoE's next rate meeting, Pill added. Markets are fully pricing in a 1 percentage point increase to 3.25% and see rates at 5.75% by May 2023.
The BoE wanted to ensure it was not perceived as bailing out the government by offering more permanent support, said Luke Bartholomew, senior economist at abrdn.
"While the Bank certainly needs to reassert its independence and the primacy of its price stability mandate, it is far from clear how credible such statements are given the degree of vulnerability exposed in the gilt market," he said.