UK government’s massive tax cutsGBPThe slump and the bond market were sold off. The Bank of England (BOE, the central bank) on Wednesday (28th) rushed to rescue the market, announcing that it would buy long-term government bonds to avoid the outbreak of the financial crisis. All this seems to be the market turmoil caused by the UK’s own fiscal policy, but it highlights the fragility of the financial market in the era of easing exit.
1. Why is the Bank of England buying bonds once more?
Prime Minister Liz Truss’ government pushes for tax cuts and energy subsidies in hopes of boosting growth, but markets sell off sharplyGBPAnd British government bonds, which have wiped $500 billion off the UK equity and bond market since Trus took office.
The sell-off in British bonds has represented a surge in yields, particularly long-dated bonds, affecting pensions, the housing market and raising the risk of a recession.
Therefore, the Bank of England hopes to urgently inject confidence through bond purchases and restore market order, especially in the pension industry, which is particularly sensitive to long-term bond yields.
But the Bank of England stressed that this is only a temporary measure to avoid panic selling, and it is different in nature from the rescue measures in the outbreak of the epidemic in 2020, Brexit in 2016 or the financial tsunami in 2008.
2. What can the Truss government do?
After the market rout, some investors believe the only way the new government can save market confidence is to scrap tax cuts, but the Truss government does not appear to have any intention of doing so for now.
Downing Street further said it would announce more economic reforms, which might include changes to the immigration system, stronger investment in people and infrastructure.
3. How are the latest developments affecting the UK housing market?
GBPThe funding market determines mortgage rates, and the recent volatility in the market has strained lenders that provide loans. Some banks have opted to suspend approving loans to new customers, while some operators have significantly increased the interest rates on new loans, making it unaffordable for many existing homeowners who want to increase their loans, or those applying for new loans.
Mortgage rates for new customers are now around 5-6%, well above the level of around 2% in the past five years, raising fears that the UK housing market might deepen the decline.
4. YesGBPinfluences
GBPDespite the rebound on Wednesday, it is still down 6% once morest the dollar since September, almostEURTwice as much, it means the UK will be under more inflationary pressure than European countries due to currency devaluation. Markets are betting that the Bank of England will raise interest rates sharply from the current 2.25% to nearly 6% by May next year.
Many UK exporters haveGBPBenefit from depreciation, as many raw materials and components are imported. but,GBPDevaluation might help lift Britain’s tourism industry.
Due to the limited foreign exchange reserves, it is difficult for the Bank of England to directly intervene in the foreign exchange market like the Bank of Japan.
5. A giant experiment in the era of easy exits
Although the Bank of England acted because of the “Made in England” problem, some factors that caused this dilemma are not unique to the United Kingdom, such as the easing exits that are being carried out by countries all over the world.
Since the financial crisis, central banks around the world have been using ultra-low interest rates and bond-buying programs to keep borrowing costs in check, but financial markets are looking increasingly vulnerable now that central banks are shutting down the taps for funding amid soaring inflation.
Paul Holiingsworth, chief UK economist at BNP Paribas, said the UK “was the first country to use fiscal policy to test market resolve in the context of interest rate hikes and balance sheet reductions”, but the UK would not be the last, which might be used by other countries Take, for example, the recently elected Italian government.
The market panic caused by the exit from the easing policy is not new. In 2013, the financial market fell into a “taper tantrum” due to the Federal Reserve (Fed). But the biggest difference between the present and the past is the scale. The stimulus measures during the epidemic have been enormous, and the global debt has ballooned significantly in the past decade.
Many central banks have raised interest rates this year, while others have simultaneously initiated quantitative tightening (QT). The two-pronged tightening has led to dramatic volatility in the interest rate market, with U.S. bond yields and global funding costs skyrocketing by more than 200 basis points, and currencies must also struggle once morest a strong dollar.
Some have predicted that U.S. debt might also be caught in a turbulence similar to that seen in the U.K. bond market, forcing the Fed to reverse course entirely.
Peter Boockvar, chief investment officer at Bleakley Financial Group, said: “We are witnessing a further disintegration of the great central bank experiment of the past 15 years. People think this is a unique event in the UK, but if the violent tremor in bonds continues, the Fed may not be able to take the lead in QT. If you go too far on the road, let alone raise your interest rate.”
