The facade of the Bank of England in London, August 6, 2020 ( AFP / DANIEL LEAL-OLIVAS )
The Bank of England again intervened on Tuesday in the face of “dysfunctions” of markets and risks of “financial instability” without however reassuring investors, while the IMF called on London not to thwart monetary policy efforts.
The central bank had already launched on September 28 a program to buy back long-term Treasury bills of up to 65 billion pounds.
It raised the maximum size of its daily operations to 10 billion pounds on Monday. On Tuesday, it widened its action to “linked bonds” on inflation, which represent around a third of British Treasury bonds.
The operation has not yet calmed the British debt market and the 30-year government borrowing rates ended up at 4.80%.
The Bank of England described “a significant risk to the financial stability of the United Kingdom”.
The International Monetary Fund (IMF), during a press conference on Tuesday for the publication of its latest economic forecasts, recalled that financial stability is part of the “mandate of central banks”.
“On the one hand, they continue monetary tightening in the face of inflationary pressures and at the same time face pockets of market dysfunction, in the case of the UK, perhaps pension funds and LDI investments,” commented IMF economic adviser Pierre-Olivier Gourinchas.
– Two people at the wheel –
The surge in government borrowing rates – which represent the cost at which the United Kingdom finances itself – is accompanied by a plunge in the price of these securities, a sign of the mistrust of investors who are offloading them.
However, these assets are very popular with British pension funds. In addition, many of these funds use so-called LDI (“Liability Driven Investments”) strategies which use derivatives, in particular government debt securities.
Given the drop in value of these assets in recent days, they have to reinject 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 takers.
The BoE notably intervened to break this vicious circle and avoid weakening pension funds and spreading to other markets and the real economy.
But its purchases of government debt securities are only scheduled until Friday and investors are worried about what will happen next. Hence the feverishness that persists.
The government of Liz Truss had set fire to the powder by presenting on September 23 a “growth plan” consisting of colossal support for electricity bills combined with vast tax cuts, without these actions being fully quantified or financed.
Investors began to sell off some British assets: the pound sterling plunged to its all-time low and the price of long-term debt securities melted.
Chancellor of the Exchequer Kwasi Kwarteng has tried to calm things down by putting forward, in the face of repeated calls from economists and parliamentarians, a budget presentation for 31 October instead of 23 November.
British Finance Minister Kwasi Kwarteng at the Conservative Party Congress on October 4, 2022 in Birmingham (AFP / Oli SCARFF)
A decision hailed by the IMF even if Mr. Gourichas criticized the action of Downing Street.
“Fiscal policy objectives should be aligned with monetary policy objectives. If you have a central bank trying to tighten” rates in the face of high inflation as is the case in the UK, and in while the government “wants to stimulate demand” with a massive budget package, “it’s like having a car with two people trying to turn the steering wheel in a different direction”, he argued.
The Fund, in its autumn report on the economy on Tuesday, forecast a significant slowdown in British economic activity (projected growth up slightly to 3.6% in 2022 but lower in 2023 to 0.3%).
He believes that even if the government manages to boost the Gross Domestic Product (GDP) slightly and in the short term with its budget announcements, it will at the same time complicate the fight against inflation given their magnitude and the financing provided by borrowing.
British markets are therefore likely to remain turbulent until the presentation of Mr. Kwarteng on October 31, who will find himself under pressure by then to find cuts in government spending to finance his expensive “growth plan”.