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Investors remain calm despite political chaos Pound rallies as Liz Truss announces resignation
(about 2 hours later)
UK government borrowing costs edged up initially on Thursday as investors watched the latest political turmoil. The pound rose against the dollar on the news of Prime Minister Liz Truss's resignation, before shedding some of the gains.
However, while interest rates - or yields - on government bonds climbed at first, they then fell back and remain below levels seen earlier in the week. Sterling touched $1.13 at one point before slipping back.
One analyst said the markets were "watching in a kind of stunned, open-mouthed horror" at political events. UK government borrowing costs had been falling ahead of the PM's statement, but then began to edge back up.
However, he added markets had not moved much, as investors are waiting for the next development. One analyst said the reaction of the markets indicated they were "relieved" by Ms Truss's departure despite there still being a lot of uncertainty.
"Markets are simply voting machines about what they expect will happen next," Bill Blain of Shard Capital told the BBC's Today programme. "So the markets really need a signal and if we get a positive signal will go up. "Overall, the resignation of Truss is a step that needed to happen for the UK government to move further along the path towards restoring credibility in the eyes of the financial markets," said Paul Dales, chief UK economist at Capital Economics.
"The problem we've got is that the last couple of weeks has really destroyed the image of political competency and that's one of the key elements to make any economy work. "But more needs to be done and the new prime minister and their chancellor have a big task to navigate the economy through the cost of living crisis, cost of borrowing crisis and the cost of credibility crisis."
"There are three things you need: you need a stable currency, you need a sustainable bond market and you need competent politics, and because it looks like competent politics are broken that's creating the volatility that we're seeing in markets." Ms Truss said her successor would be elected in a Tory leadership contest, to be completed in the next week. Her resignation comes after a key minister quit and Tory MPs rebelled in a chaotic parliamentary vote on Wednesday.
Prime Minister Liz Truss is under renewed pressure after the home secretary quit on Wednesday and MPs took part in a chaotic vote on fracking. The Treasury has confirmed that the statement on the chancellor's economic plan will go ahead as scheduled on 31 October.
Firms hold off investment due to Tory turmoilFirms hold off investment due to Tory turmoil
Government borrowing costs rose sharply last month after it unveiled a tax-cutting mini-budget without saying how it would pay for it. Government borrowing costs rose sharply last month after it promised huge tax cuts in its mini-budget without saying how it would pay for them.
But these costs then fell back after the Bank of England stepped in with its emergency support programme, and after Jeremy Hunt reversed nearly all the mini-budget measures when he became chancellor. But these costs fell back after the Bank of England stepped in with an emergency support programme, and after Jeremy Hunt reversed nearly all the mini-budget measures when he became chancellor.
What are government bonds?What are government bonds?
The government can raise money by selling bonds - also known as gilts - to investors. Bonds are a bit like an "I owe you".The government can raise money by selling bonds - also known as gilts - to investors. Bonds are a bit like an "I owe you".
Typically, the government agrees to repay the investor on a certain date in the future. In the meantime it pays interest on the loan.Typically, the government agrees to repay the investor on a certain date in the future. In the meantime it pays interest on the loan.
However, the mini-budget hit confidence in bonds, and led to investors demanding a much higher rate of interest in return for investing in them. Some bonds halved in value.However, the mini-budget hit confidence in bonds, and led to investors demanding a much higher rate of interest in return for investing in them. Some bonds halved in value.
The interest rate - or yield - on UK government bonds for borrowing over a 10-year period climbed above 4% at one point on Thursday morning, although this only brought the rate back to the level it had been 24 hours earlier. The interest rate - or yield - on UK government bonds for borrowing over a 10-year period climbed above 4% at one point on Thursday morning, but then fell back steadily as speculation grew about Ms Truss's possible departure.
The rate remains below the levels seen in the immediate aftermath of the mini-budget, but it is still higher than before the announcement. However, following the PM's statement, the rate edged higher again to about 3.8%.
Analysts said UK borrowing costs were still higher than in similar countries. Ahead of the PM's resignation, Bill Blain of Shard Capital had told the BBC that the markets were "watching in a kind of stunned, open-mouthed horror" at political events.
Simon French, chief economist at Panmure Gordon, told the BBC: "The UK Government can borrow for 10 years at about 4% - that number has come down in recent days, but it's [the UK Government] paying about 0.75% more than it really should be if you benchmark the cost of government debt against other comparable countries. "The problem we've got is that the last couple of weeks has really destroyed the image of political competency and that's one of the key elements to make any economy work," he said.
"That progress in getting that interest rate down will have been stalled by yesterday's events." "There are three things you need: you need a stable currency, you need a sustainable bond market and you need competent politics, and because it looks like competent politics are broken that's creating the volatility that we're seeing in markets."
The pound remained steady against the US dollar on Thursday, trading at about $1.12, although this is lower than the level of $1.14 it hit on Monday following the announcement that most of the mini-budget measures were being scrapped.
Sterling slipped slightly after comments from Bank of England deputy governor Ben Broadbent suggested that the Bank might not raise interest rates by as much as expected at its meeting next month.
In a speech, Mr Broadbent said the Bank's Monetary Policy Committee - which decides the level of interest rates - was "likely to respond relatively promptly to news about fiscal policy", following the reversal of many of the mini-budget changes.
"Whether official interest rates have to rise by quite as much as currently priced in financial markets remains to be seen," he said.