British Central Bank Will Have ‘Significant’ Response to Government’s Fiscal Plans

The new British government’s plan for tax cuts, borrowing and spending will be met with a “significant” response by monetary policy officials, Huw Pill, the chief economist of the Bank of England, said on Tuesday. That could pit the central bank’s effort reduce inflation by cooling demand against the government’s desire to stimulate the economy.

At the end of last week, Kwasi Kwarteng, the chancellor of the Exchequer, spooked financial markets when, without citing an independent fiscal and economic assessment, he revealed plans for the biggest tax cuts in half a century and an increase in government borrowing. On Monday, the pound dropped to a record low against the U.S. dollar, and analysts began to predict it would soon reach parity, or a one-to-one exchange rate. British borrowing costs shot higher as bond yields jumped to the highest levels in more than a decade, disrupting the mortgage market as traders bet the central bank would have to raise interest rates aggressively to tame inflation.

In a statement on Monday, the Bank of England appeared to rule out any interest rate increases before its next meeting in early November. Mr. Pill indicated that when the time came for a move it would be “significant,” a word he used often.

“We have all seen the recent significant fiscal news in the past few days,” Mr. Pill said on Tuesday at a conference hosted by Barclays and the Centre for Economic Policy Research in London. “That has had significant market consequences as well as significant implications for the macro outlook.”

“It’s hard not to draw the conclusion that all this will require a significant monetary policy response,” he added.

The government’s policies, which include capping energy costs for businesses and households, “will act as a stimulus to demand in the economy,” Mr. Pill added, offering some of the first glimpses into how the bank will assess the recently announced measures.

One of the criticisms of the government’s policies is that they pull in the opposite direction to the central bank’s goal of bringing down inflation, which is near a 40-year high. Last week, the cental bank raised interest rates by half a percentage point, disappointing some who thought that the move would be larger. The next day, the chancellor’s announcement on tax cuts and other measures shocked markets. Since then, traders have added to bets on interest rates to rise even more.

Mr. Pill also described the changes in British financial assets as significant. He said that these changes were part of a shift in asset prices in response to higher interest rates around the world, but there was “very clearly a U.K.-specific element.”

Policymakers at the central bank “are certainly not indifferent to the re-pricing of financial assets we have seen,” Mr. Pill said.

Because Britain is a small, open market economy, higher bond yields and a weaker currency have an “important influence” on the cost of financing and price of imports, he said.

On Tuesday, the pound was trading below $1.08, up from its recent lows but still at levels unseen since the mid-1980s. Yields on benchmark 10-year bonds were at 4.51 percent, the highest since the financial crisis of 2008.

In all, the market moves have made the bank’s job of bringing down inflation harder, he said. Inflation is currently about five times the bank’s 2 percent target, even after seven interest rate increases since late 2021.

“Recent market developments have created their own additional challenges for the pursuit of our target,” Mr. Pill said.

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