The Bank of England has today staged its third intervention in the gilt markets in under three weeks. As it is also its second intervention in as many days, the situation looks alarmingly dicey ahead of Friday, when the Bank originally intended to end its emergency gilt-buying programme.
Let’s recap. Before the mini-Budget, the Bank of England planned to start disposing of government bonds. This was quantitative tightening – the beginning of the end of the loose monetary policy that has persisted since 2008 and was ramped up by the pandemic. This was part of its broader – if worryingly slow – efforts to tighten monetary policy by raising interest rates in response to spiralling inflation.
But in the same way Andrew Bailey was unprepared for inflation to be anything other than transitory, the Bank – alongside the Chancellor himself – was taken aback by the market reaction to the mini-Budget. Rather than be pleased at the prospect of supply-side reform, lower taxes, and bigger bonuses, the markets were spooked.
This took the form of surging gilt rates, reflective of the cost at which the Government borrows. This threatened a collapse in our pensions market as pension funds were pushed into selling up in order to pay off the collateral from banks. To prevent a ‘material risk’ to the UK’s financial stability, the Bank announced a £65 billion programme of gilt-purchasing. This reversed its earlier course, caused yields to fall, and temporarily stabilised the markets.
But yesterday, with Friday looming into view, the Bank extended its programme by doubling its purchasing limit for long-term gilts from £5 billion per day to £10 billion and pledged to continue intervening beyond Friday to ensure pension funds remain stable. Meanwhile, gilt yields soared to their highest level since the mini-Budget, at 4.7 per cent for 30-year UK bonds.
Today, the Bank went even further, by adding index-linked government bonds to its purchases until Friday. Coinciding with a sale of these bonds today, the Bank is attempting to calm the market for government debt, and drive borrowing costs down. So far, it appears the markets are not overtly keen on playing ball, and expect something bigger.
All of this makes a change in course on Friday very unlikely. Bailey may have been tone deaf in the past, but even he couldn’t but fail to notice the jitteriness amongst investors about what the markets would do if the Bank stepped away. With Kwarteng’s fiscal plan and a likely interest rate rise still weeks away, the situation is little changed from before the Bank’s intervention.
Fundamentally, the Chancellor has done a very good job at very quickly losing the confidence of the markets. After the mini-Budget, they are worried the country will not be able to pay its bills. The Government does not appear to have the authority to either pass significant supply-side reforms or implement spending cuts. But they do not want to raise taxes or u-turn to revive Rishi Sunak’s. Rock, meet hard place.
Yet the Bank has hardly covered itself in glory. It was unprepared for inflation, and then claimed it would be transitory. It has consistently lagged the Federal Reserve in raising rates. Truss and Kwarteng would have been right to criticise its performance, if only doing so wouldn’t give a collective coronary to the very same investors they must keep on side.
So only further action from Bailey and co will restore some form of stability. But, as yesterday showed, it will have to go further than that announced so far, since that has done little to hold gilts down. If Friday fails to prevent another panic, I would expect that either the next rate rise or the Chancellor’s fiscal plan will need to be brought forward. Something substantial must be done to end the instability.
Something substantial must be done to end the instability. Then again, I could hardly rule out more fudging by the Bank or the Treasury. The story of the last few weeks has been a consistent failure of both institutions and their heads to first see what will happen next, and then to vacillate sufficiently to make the situation worse.
Plus, holding Kwarteng’s big announcement on Halloween does make some kind of sense. After all, it is the one day of the year when the markets should expect to get spooked.