The facade of the Bank of England in London, August 6, 2020 ( AFP / DANIEL LEAL-OLIVAS )
The Bank of England intervened again on Tuesday amid “market dysfunction” and risks of “financial instability” but without reassuring investors, while the IMF urged London not to thwart monetary policy efforts.
The central bank had already launched a program to buy back up to £65 billion of long-dated Treasury bills on September 28.
On Monday it increased the maximum size of its daily operations to £10billion. On Tuesday, it extended its action to include “linked bonds” on inflation, which account for around a third of UK government bonds.
The operation has yet to calm the UK debt market and 30-year government lending rates ended up at 4.80%.
The Bank of England described “a significant risk to the UK’s financial stability”.
The International Monetary Fund (IMF) reminded on Tuesday that financial stability is part of the “mandate of central banks” during a press conference to release its latest economic forecasts.
“On the one hand, they continue monetary tightening in the face of inflationary pressures while at the same time facing market disruptions, in the UK’s case perhaps pension funds and LDI investments,” commented IMF economic adviser Pierre-Olivier Gourinchas.
– Two people behind the wheel –
The rise in interest rates on government bonds – which is the cost at which the UK finances itself – has been accompanied by a fall in the price of these securities, a sign of distrust from investors who are selling them.
However, these investments are very popular with British pension funds. In addition, many of these funds use so-called LDI (“Liability Driven Investments”) strategies, which use derivatives, particularly government bonds.
As these assets have fallen in value over the past few days, they need to replenish liquidity – the phenomenon of margin calls. This forces them to sell securities quickly. Hence the risk of an uncontrolled downward spiral and a market where the assets no longer find buyers.
In particular, the BoE intervened to break this vicious circle and avoid a weakening of pension funds and a spillover to other markets and the real economy.
But government bond purchases are only scheduled through Friday, and investors are worried about what will happen next. Hence the persistent fever.
Liz Truss’ administration had set the powder alight by unveiling a “growth plan” on September 23 that consisted of colossal support for utility bills combined with massive tax cuts, without these measures being fully quantified or funded.
Investors started to sell some UK assets as sterling fell to its all-time low and the price of long-dated debt melted.
Chancellor of the Exchequer Kwasi Kwarteng has tried to calm the situation by presenting a budget proposal for October 31 instead of November 23, despite repeated calls from economists and parliamentarians.
UK Finance Minister Kwasi Kwarteng at the Conservative Party Congress in Birmingham on October 4, 2022 (AFP/Oli SCARFF)
A decision welcomed by the IMF, although Mr Gourichas criticized Downing Street’s actions.
“Fiscal policy objectives should be balanced with monetary policy objectives. When you have a central bank trying to tighten rates in the face of high inflation, as is the case in the UK, and while the government is on a ‘demand boost’ agenda. huge budget package, “it’s like a car with two people trying to turn the steering wheel in a different direction,” he argued.
The fund forecast a sharp slowdown in UK economic activity (projected growth slightly to 3.6% in 2022 but lower to 0.3% in 2023) in its autumn report on the economy on Tuesday.
Even if the government manages to give a slight short-term boost to gross domestic product (GDP) with its budget announcements, he believes that, at the same time, fighting inflation will be made more difficult given its scale and financing through borrowing.
UK markets are therefore likely to remain turbulent until the October 31 presentation of Mr Kwarteng, who will come under pressure to find cuts in government spending to fund his expensive ‘growth plan’.
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