Sterling, markets drop again as BoE boost wears off

HONG KONG, China — The pound and European equities fell Thursday after the previous day's bank of England-fuelled rally, with investors growing increasingly worried about the UK economy as Prime Minister Liz Truss backed the controversial mini-budget that sparked turmoil across global markets.

The central bank sparked a surge across risk assets Wednesday following the announcement of a two-week programme to spend £65 billion ($71 billion) buying long-dated UK bonds "to restore orderly market conditions".

The move came after new finance minister Kwasi Kwarteng unveiled a tax-cutting mini-budget Friday that many experts, including the International Monetary Fund, warned would fan borrowing and deal a further blow to the already fragile economy.

Kwarteng's plan sent yields on UK government bonds, as well as those of other countries, soaring and raised the prospect of even bigger interest rate hikes.

The BoE move provided a massive shot in the arm for investors, pushing yields down, and sterling and stock markets up. Analysts said the decision provided some hope that central banks were ready to step in with support if things got too bad.

However, the impact was short lived as traders continue to worry about the long-term effect on the UK economy from the budget.

"The Bank moved to stop contagion, but stress remains and it remains the case that it must tighten policy faster to offset the effects of the budget," said Markets.com analyst Neil Wilson.

The new round of easing also knocked the BoE's plan to fight inflation off course as it had to suspend a programme to sell "gilts", which had helped lift borrowing costs.

The pound fell back below $1.0800 Thursday, having spiked at $1.0900 earlier, while the FTSE 100 plunged more than two percent. Paris and Frankfurt were not far behind as data showed German inflation had hit 8.8 percent. Still, in some bright news, Spain said price rises slowed to below 10 percent this month.

That came after most Asian markets enjoyed a rare day of gains.

Truss appeared to push back against calls for her to perform a U-turn.

"We're facing very, very difficult economic times, we’re facing that on a global level," she said Thursday in interviews with local BBC radio stations.

"We had to take urgent action to get our economy growing and that means taking controversial and difficult decisions," she said in her first comments since the storm erupted.

OANDA's Edward Moya warned of more rough seas for sterling.

"The British pound went on a little roller coaster ride following the BoE action to buy unlimited long-dated gilts, but will still probably remain heavy over the country's fiscal situation, current account deficit, financial stability risks, and energy poverty likelihood for parts of the population," he said in a note.

And MUFG analyst Lee Hardman said the BoE move "has certainly upped the level of concern over the potential negative economic and financial market fallout from the loss of confidence in UK's public finances".

The general mood on trading floors remains dark as the Fed and other central banks zero in on hiking borrowing costs to fight decades-high inflation.

"All eyes are on inflation and interest rates," said Josh Emanuel at Wilshire. "Equities are really going to take their cues from bond markets. So if you see bond yields move lower, that is a good sign for equities."

Julia Raiskin at Citi added that "markets are very pessimistic... Other than the dollar, there are not many assets that are trading constructively."