The Bank of England’s next scheduled policy meeting on November 3 is still a long way off. With the pound falling to a record low against the dollar this week and Britain’s borrowing costs soaring, market soothsayers have called for intervention between meetings. But Governor Andrew Bailey has resisted the temptation – and he’s right not to fall into the trap traders are setting for him.
On Friday, the government unveiled the biggest raft of tax breaks in half a century, and Chancellor of the Exchequer Kwasi Kwarteng promised “more are to come”. This tax treat, combined with energy bill offsets for households and businesses that will cost £60bn ($64bn) over the next six months alone, has rocked sterling markets, with sterling bearing the brunt of investor unease.
As such, speculation mounted on Monday as to how the BOE would respond. Futures markets began anticipating an emergency rate hike in the coming weeks. The prospect of verbal intervention to support sterling helped the pound recoup losses against the greenback.
“If I were still at the BOE I would be tempted to announce an additional meeting in a week’s time,” Sushil Wadhwani, who was a UK interest rate setter until 2002 before founding his quantitative hedge fund PGIM Wadhwani, said on Monday. “The argument for waiting a week would be to give them time to properly assess the additional news. The reason for not waiting until November is that they are aware of the need to respond to the new developments in a timely manner.”
Finally came a statement from Bailey late Monday saying the central bank would make a “full assessment” of the impact of the UK government’s budget plans and the fall in sterling “at its next scheduled meeting” and would “act accordingly”. . In other words: keep calm and move on. Stick to the schedule. Don’t be swayed by the hedge funds trying to take advantage of market turmoil. keep your distance
The Monetary Policy Committee voted 5-4 last week to raise the official interest rate by half a point to 2.25%, with three panel members backing a larger hike of 75 basis points. In the statement accompanying the decision, the MPC said it would “react vigorously as needed” if inflationary pressures continue to become more persistent.
The futures market is already testing this commitment as the government’s tax gift is likely to stoke an inflation rate already close to five times the central bank’s 2% target. At some point Monday, traders were expecting official borrowing costs to be 80 basis points higher in the coming week. But the market is still predicting an official interest rate that is bloody high at the next BOE meeting, albeit a little less surreal in magnitude.
This rise in market interest rates could crush the UK property market. The cost of a two-year fixed-rate mortgage – the most popular option among UK borrowers in recent years – with a 75% loan-to-value ratio is already at its highest level in a decade for August, according to Bank of England data. And that doesn’t include the rise in borrowing costs over the past few days.
Neal Hudson, a visiting fellow in real estate and planning at Henley Business School, estimates that 300,000 borrowers per quarter are having to refinance their fixed-rate mortgages at the new, higher interest rates, with the number peaking at 375,000 in the second quarter of next year. Put another way, around 1.4 million UK households will refinance their mortgages in the coming year, out of the current 9 million owner-occupied and 2 million rental mortgages. But the central bank’s job is to stem rising consumer prices, not keep the housing market afloat.
There is a bigger problem facing the financial markets. The BOE is set to start selling the pile of bonds worth more than £800 billion it has amassed through quantitative easing. At the same time, if they sell these, the government will have to issue more debt to fund its fiscal extravagances, which could exacerbate the rise in bond yields: the UK’s five-year borrowing costs have risen above those of Italy and Greece in recent days.
However, the central bank has said that there is “a high bar for changing the planned reduction in the stock of gilts purchased”. It is also suggested that only the risk of disordered markets would lead to a pause in selling; For now, the government bond market appears to be functioning normally, although yields have risen sharply.
So halting plans to sell its bond holdings risks the central bank being interpreted as admitting that it has lost control of the gilt market. That would be a dangerous path given that the pound has already effectively left it to the whims of the FX market.
FX market intervention, even if only verbal, would also risk exacerbating sterling’s woes and rekindling traumatic memories of the pound’s exit from the European Exchange Rate Mechanism in 1992. Last week, the Bank of Japan intervened to defend the yen for the first time since 1998, saying, “The government is concerned about excessive moves in the forex markets.” But there, the currency is falling as interest rates remain unchanged, making the difference increased with higher US borrowing costs. The UK is in a different situation; If the Treasury or the Central Bank had even hinted that they were trying to influence the value of sterling, traders would smell blood.
Huw Pill, the BOE’s chief economist, will address a conference on ‘Economic and Monetary Challenges Ahead’ in London on Tuesday at 12pm. Let’s hope he resists the temptation to go off-piste; His comments, which are believed to have been checked by the central bank, will come under even more scrutiny than usual.
Fiscal and monetary policies are diametrically opposed in the UK right now, with the Treasury stepping on the gas while the central bank is stepping on the brakes. A driver on a track looking for a controlled skid can simultaneously use the accelerator and handbrake to shift the car’s inertia to cause it to drift sideways around a corner. However, incorrect calibration between acceleration and braking can lead to disaster.
The pound is the immediate victim, along with the cost of credit; It remains to be seen whether the change in government fiscal policy will cause interest rate setters to overreact. For the time being, however, the BOE is right to keep their hands off the steering wheel.
More from the Bloomberg Opinion:
Truss’ economic plan is hardly a disaster: Tyler Cowen
Market meltdown sends UK government warning: Mark Gilbert
Is Kwasi Kwarteng ready to bail out Britain’s economy?: Adrian Wooldridge
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Mark Gilbert is a Bloomberg Opinion columnist covering wealth management. A former head of Bloomberg News’ London bureau, he is the author of Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.
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