September 29, 2022 | 14:53
It seems that there may have been two cases of sabotage this week. One could have been intentional: Russia was accused of damaging the Nord Stream 1 and 2 pipelines, causing an unknown quantity of methane to leak into the Baltic Sea. Estimates range from “they do not pose any serious threat to the marine environment” to “it has the potential to be one of the biggest gas leaks”. The other was unintentional: U.K. PM Truss and Chancellor Kwarteng’s massive and inflationary £161 bln “mini-budget” counters what the BoE has been trying to achieve (price stability), and then some.
Let’s go back a month or so. The biggest concern for the economy was the planned 80% surge in utility bills that would have crushed the British consumer when it took effect October 1st. But, PM Truss’ Energy Price Guarantee quickly dealt with that by freezing households’ monthly bills for the next two years. Crisis averted. But wait, the PM wasn’t finished. Her new Chancellor stepped up with a fiscal stimulus package that was anything but “mini”, with the largest tax cuts since 1972. The goal is to grow the economy and to make sure that “Britain is an attractive place to invest”.
Ironically, the package had the opposite effect, with the GBP crashing to a record low $1.035 this week, and yields surging across the curve, including 30-year Gilts hitting a 20-year high of over 5%, all on fears that 40-year high inflation will head even higher with such large amounts of stimulus. And how these tax cuts would be funded was a little fuzzy. Even the IMF spoke up, in a rare rebuke, stating that “we do not recommend large and untargeted fiscal packages at this juncture… It is important that fiscal policy does not work at cross purposes to monetary policy”. Moody's will decide on any credit rating changes on October 21... but it doesn't look good.
Ain’t that the truth. The BoE is fighting double-digit inflation, brought on by global energy and food prices, excess labour demand and goods supply shortages. Policy rates are up 200 bps from pandemic lows, and plans for at least another 50 bps at the November meeting were in the works, depending on what fiscal measures Chancellor Kwarteng was going to introduce. And, Gilt sales were scheduled to begin next week.
All of those plans have now taken a backseat as Governor Bailey tries to stop the “dysfunction” in financial markets from continuing or worsening, as it would pose a material risk to U.K. financial stability. The Bank will buy up to £5 bln worth of Gilts with maturities of at least 20 years each day until October 14. That’s 13 weekdays, or up to a total of £65 bln. If more is needed, then so be it, as it will buy “on whatever scale is necessary” to restore order to the market (said another way... ‘we will do whatever it takes’). When order is restored, the BoE will go ahead with its plans to sell £80 bln of bonds over the next 12 months, starting at the end of October. And about those rate hikes… well, they have to be even bigger now, to offset the inflation risk posed by the weaker GBP, profligate fiscal policy, and to potentially offset the purchases at the long end. A full 100 bp rate hike on November 3 is now expected, and the possibility of an inter-meeting move cannot be dismissed if the GBP tests new lows again.
On a side note, German CPI blew past expectations, surging a record 10.9% y/y in September. Belgian CPI also rose at the fastest pace since March 1976 at 9.9%. That pretty much solidifies a 75 bp rate hike by the ECB in October.