How will and how should the Bank of England, and the Treasury, react to this morning’s continued fall in the value of the pound? I’ve been talking to former Bank of England executives and ex-Treasury officials, who make clear that the stakes are incredibly high and that reassuring markets will not be easy.
This further devaluation in the currency is a serious problem for Chancellor Kwasi Kwarteng after his maxi ‘mini-Budget’ on Friday because it means the price of imports will continue to rise, stoking already-high inflation. And it raises the spectre that the government will struggle to borrow what it needs at acceptable interest rates, because of the falling value (in dollar terms) of sterling-denominated assets. The fall in the value of sterling carries a simple message: investors are concerned that the Bank of England will not raise interest rates as much as they deem necessary, after what they see as the inflationary impact of Kwarteng’s budget. This in turn puts the onus on the Bank of England to prove markets wrong.
There are two ways the Bank can do that. First, it could hold an emergency meeting to raise interest rates by more than the 0.5 per cent announced only last Thursday. That, however, would almost certainly be a disaster for the reputations of the Bank of England and of the Treasury – and would only be a very last resort, in extreme crisis.
How so? If the Bank of England held such an emergency meeting on its own initiative, it would in effect be telling the world it had lost confidence in Kwarteng and the Treasury – because it would be saying that such is the damage wreaked by Kwarteng to the value of UK assets, the Bank could not risk waiting till its 3 November meeting to assess the inflationary impact of the Budget.