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The Bank of England in the City of London. Image Credit: AFP

UK bonds surged after the Bank of England said it would carry out temporary purchases of long-dated UK bonds on Wednesday and delay planned sales of debt.

The yield on 30-year gilts plummeted 26 basis points to 4.72 per cent after earlier rising as much as 15 basis points to the highest since 1998. The pound briefly spiked before falling back.

The UK government's "big gamble" in announcing unfunded tax cuts means the Bank of England now needs to raise interest rates by at least 100 basis points at its next meeting on Nov. 3, according to Mohamed El-Erian, chief economic adviser at Allianz SE.

While Chancellor of the Exchequer Kwasi Kwarteng's structural reforms promoting growth and the stabilization of energy prices were sound policies, the unfunded tax cuts undermined the first two and are now counterproductive, he said in an interview with Francine Lacqua on Bloomberg TV.

IMF urges UK to reconsider

The International Monetary Fund on Tuesday urged the UK government to reconsider the massive unfunded tax cuts announced Friday. The measures shocked investors, roiled markets and led to at least $500 billion in combined UK stock and bond market losses.

If the government wants to stabilize the situation they should postpone the large unfunded tax cuts and provide more information on the growth measures, according to El-Erian.

That, and a BOE rate hike, would reverse some of the price moves that are going to have a "huge impact on economic prospects and inequality," he said.

El-Erian said UK households are being hurt by higher borrowing costs, a negative wealth effect, an income effect from worries about a recession and the inflation effect on things like food.

"It's hard to hit the population, both households and businesses, with these four things at the same time and not expect major damage," he said. "The government has time now to try and get the situation back under control."