Bank of England right to snub calls for emergency action

The next monetary policy meeting scheduled by the Bank of England on November 3 is a long way off. As the pound falls to a record low against the dollar this week and borrowing costs in the UK rise, market soothsayers have called for intervention between meetings. But Governor Andrew Bailey has resisted that temptation – and he is right not to fall into the trap set for him by traders.

On Friday, the government revealed the biggest slate of tax cuts in half a century, and Chancellor of the Exchequer Kwasi Kwarteng promised “more to come”. The tax giveaway, combined with a household and business energy bill offset that will cost £60bn ($64bn) over the next six months alone, has rattled sterling markets, with the pound bearing the weight of investor unease.

Speculation on the reaction of the BOE therefore mounted on Monday. Futures markets have started pricing in an emergency rate hike in the coming weeks. The prospect of verbal intervention to support the pound helped the pound recoup its losses against the greenback.

“If I were still at the BOE, I would be tempted to announce an additional meeting in a week,” Sushil Wadhwani, who served as a UK rate regulator until 2002 before founding its quantitative hedge fund PGIM Wadhwani. “The argument for waiting a week would be to give them time to properly assess the additional news. The reason they didn’t wait until November is because they realize the need to respond in a timely manner. to new developments.

Ultimately, a statement from Bailey came in late Monday saying the central bank would make a “full assessment at its next scheduled meeting” on the impact of the UK government’s budget plans and the fall in the pound sterling, and “would act accordingly”. In other words, keep calm and carry on. Stick to the schedule. Don’t be swayed by hedge funds looking to profit from market turbulence. Stay away.

The Monetary Policy Committee last week voted 5-4 to raise the official interest rate by half a point to 2.25%, with three panel members in favor of a bigger 75% increase. basis points. In the statement accompanying the decision, the MPC said it would “respond forcefully if necessary” if inflationary pressures began to become more persistent.

The futures market is already testing that commitment, given that the government’s tax giveaway is likely to fuel an inflation rate that is already nearly five times the central bank’s 2% target. At one point on Monday, traders were pricing in an 80 basis point higher official cost of borrowing over the coming week. But the market is still predicting a nosebleed official rate at the next BOE meeting, albeit a bit less surreal in its rise.

This spike in market interest rates could crush the UK property market. The cost of a two-year fixed-rate mortgage – the most popular option with UK borrowers in recent years – with a loan-to-value ratio of 75% is already at its highest level in a decade, according to the Bank of England data for August. And that’s not including the spike in borrowing costs in recent days.

Neal Hudson, visiting real estate and planning scholar at Henley Business School, estimates that 300,000 borrowers per quarter need to refinance their fixed-rate mortgages at the new higher rates, with the number peaking at 375,000 in the second quarter of next year. . . Put another way, around 1.4 million UK households are expected to refinance their mortgages over the coming year, out of the 9 million homeowners and 2 million buy-to-let mortgages currently in place. But the central bank’s job is to rein in consumer price inflation, not to keep the housing market afloat.

Financial markets face a bigger problem. The BOE is expected to start selling the more than £800bn stack of bonds it has accumulated through quantitative easing. Unloading them at the same time that the government has to issue more debt to fund its budget extravaganza risks exacerbating the surge in bond yields: five-year borrowing costs for the UK have exceeded those for Italy and Greece in recent days.

The central bank, however, said there was “a high bar to alter the projected reduction in purchased gilt inventory.” It is also suggested that only the risk of disorderly markets would lead to a pause in selling; for now, even though yields have jumped, the gilt market seems to be functioning normally.

Thus, the halting of plans to sell its bond holdings risks being interpreted as the central bank’s admission that it has lost control of the gilt market. That would be a dangerous path, given that he has already effectively abandoned the pound to the whims of the foreign exchange market.

Intervention in the foreign exchange market, even if only verbal, would also risk compounding the woes of sterling and rekindling traumatic memories of the pound’s 1992 ejection from the European exchange rate mechanism. . Last week, the Bank of Japan stepped in to defend the yen for the first time since 1998, saying “the government is concerned about excessive movement in the currency markets.” But there, the currency is falling because interest rates are being held at a standstill, widening the gap with higher US borrowing costs. The UK is in a different situation; if the Treasury or the central bank even hinted that they were trying to influence the value of sterling, traders would smell the blood.

Huw Pill, the BOE’s chief economist, is due to speak at a conference on “Economic and Monetary Policy Challenges Ahead” at midday London time on Tuesday. Let’s hope it resists the temptation of going off-road; his comments, presumably approved by the central bank, will come under even more scrutiny than usual.

As things stand, Britain’s fiscal and monetary policies are diametrically opposed, with the Treasury pressing the accelerator while the central bank is braking. A driver on a race track looking for a controlled slide can use the throttle and handbrake simultaneously to shift the car’s inertia to drift sideways through a turn. However, poor calibration between acceleration and braking can lead to disaster.

The pound is the immediate victim, along with borrowing costs; it remains to be seen whether the change in government fiscal policy will lead to an overreaction from ratemakers. For now, however, the BOE is right not to touch the wheel.

More from Bloomberg Opinion:

Truss’ economic plan isn’t a disaster: Tyler Cowen

Market crash sends warning to UK government: Mark Gilbert

Is Kwasi Kwarteng ready to save the British economy? : Adrian Wooldridge

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. A former London bureau chief of Bloomberg News, he is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

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