What is the Bank of England doing in bid to stabilise UK economy?

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The Bank of England has intervened in an attempt to stabilise financial markets in the wake of steep falls in the pound against the dollar and a surge in the UK’s borrowing costs. We explain what is happening.

What has the Bank done?

Officials at the Bank said it would use the central bank’s money to effectively lend funds to the government, in an effort to bring down the interest rates on government debt.

The government raises money by issuing IOUs, or bonds, which are bought up by investors on international money markets.

The measure is billed as temporary and targeted, but has already brought down the cost of borrowing for the UK government.

Why has it acted?

The central bank was worried that panic in financial markets was increasing the UK’s cost of borrowing at an alarming rate and hoped the announcement of its intention to intervene would bring some calm.

It is also expected that stability in the debt markets will have a steadying effect on the pound.

It offers the government some respite from a financial storm that threatens to wreck its plans for a ?150bn energy price cap and tax cuts worth ?45bn.

Markets reacted negatively to the tax plans, which many analysts said would fail to lift the UK’s growth and added unwarranted sums to an already large and growing debt pile.

How does the Bank’s plan work?

If we consider the UK’s ?2.2tn of government borrowing like a billion different mortgages, some of which last a few hours while others last 30 years, the Bank of England has said it is worried about the interest rate on refinancing the 10 to 30-year loans. The interest rate on longer dated loans has doubled in recent weeks.

The loans are packaged as bonds and sold and resold on international markets. Anyone can buy a UK government bond and many of us will hold them indirectly in our pensions. In effect, we lend the government money by buying UK bonds, often referred to as gilts.

Entering the market to buy bonds adds to the number of purchasers. An increase in the number of buyers pushes up the value. A higher value tells other potential buyers that the bonds are less risky to purchase, bringing down the interest rate.

Can this plan work in the long term?

The Bank of England said the purchase of bonds was unlimited, but short-term. That is a signal to the government that it needs to revise its tax-cutting plans or risk markets returning to the panicked selling seen earlier in the week.