The UK economic outlook has deteriorated materially, the Bank of England said on Wednesday, as it insisted “lessons must be learned” from the recent turmoil to engulf bond markets.
Publishing its latest Financial Stability Report, the central bank’s financial policy committee said that since its last report in July, inflationary pressures had intensified while financial conditions had tightened globally, resulting in a “further material deterioration” in the UK’s economic outlook.
The report acknowledged that the government’s Energy Price Guarantee, announced in early September, was likely to reduce peak near-term consumer price inflation and support demand. Average household energy bills have been capped at £2,500 from 1 October for two years under the scheme.
But it also warned: “On the other hand, rapid increases in financing costs for mortgages and other borrowing will increasingly stretch UK household and business finances in coming months.”
UK financial assets had seen a “further significant repricing” in late September, the FPC said, leading to a “vicious spiral of collateral calls and forced gilt sales that risked leading to further market dysfunction, creating a material risk to financial stability”.
The government’s controversial mini-budget, published on 23 September – which initially included £45bn of borrowing-funded tax cuts but no spending review or economic forecasts – sparked turmoil across financial markets, as the pound crashed and gilt yields rose.
The central bank was eventually forced to step in with an unprecedented £65bn bond-buying programme, as it emerged some pension funds were at risk of collapse, because of rising collateral calls on liability-driven investments (LDIs).
The committee – which is tasked with safeguarding the resilience of the UK financial system – said: “While it might not be reasonable to expect market participants to insure against all extreme market conditions, it is important that lessons are learned from this episode and appropriate levels of resilience ensured.
“The Bank will work with The Pensions Regulator and the Financial Conduct Authority domestically to ensure strengthened standards are put in place.”
Central banks around the world are putting up interest rates as they look to combat inflation, which is currently at a near-40 year high in the UK. The BoE has increased the cost the borrowing seven times since December 2021, with a further hike widely forecast at its November meeting.