Thoughts

September 23, 2022 | 17:13

Brother Can You Spare a Quid?

Economist

Jennifer Lee

Senior Economist and Managing Director
Economics

(Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

(Read more)

It is always interesting to look back in time to see how things have evolved. For example, during the week of September 24, 2021:

The FOMC left the fed funds rate at the record-low level of 0.125%. It still referred to inflation as “transitory”, but added that it will be more persistent, and that if progress continues, then “a moderation in the pace of asset purchases may soon be warranted”.
The BoE unanimously decided to leave its Bank rate at a record-low 0.10%, but maintained that “some modest tightening… over the forecast period is likely”.
The Norges Bank raised rates 25 bps, and said “it is appropriate to begin a gradual normalisation of the policy rate”.
Brazil’s Copom hiked the Selic Rate 100 bps, and said more was coming.
The Riksbank left its key rate at 0.0%, and describe the unexpected inflation overshoot as “temporary”.
The BoJ maintained its rates at -0.1%, and kept 10-year JGBs around 0%.
Various ECB officials were out and about, but there was a notable comment from Vice President Luis de Guindos, who warned of the upside risks to inflation, and the risk that temporary price increases could become permanent.

Fast-forward exactly 12 months and gosh how things have changed!

The FOMC is aggressively tightening, and is not taking any prisoners.
The BoE hasn’t voted unanimously in ages, but all nine members did agree this week that they should be raising Bank Rate. The only source of debate was by how much.
Brazil actually stayed on the sidelines but this followed seven hikes in a row totaling 750 bps.
The Norges Bank is still tightening, but is ready to slow things down.
The Riksbank now knows that the inflation overshoot was not temporary, and it raised rates for the fifth time, up a shocking 100 bps to 1.75%.
But some things never change. The BoJ is still highly accommodative and stayed on hold this week. But, the MoF intervened to stop the JPY from seemingly being in free-fall, the first such move since 1998.

Aggressive tightening is still the main theme, at least for most central banks (you know who the exceptions are) but what was interesting this week is that some paused for breath, at least for now (which solidified the greenback as the queen bee). The BoE is one that is up for lots of debate. The initial reaction from this desk was that the majority of the MPC is becoming increasingly reluctant to tighten into a recession. However, a deeper read into the Minutes showed that both the 50 bp camp and the 75 bp camp wanted to wait until after the U.K. government tabled its mini-budget, which will give them a better idea of the economic impact to ponder over the next six weeks until the next rate announcement (on November 3). Both camps also focussed on the Energy Price Guarantee and felt that it would cause more upward inflationary pressures. The difference is when. The majority felt that in the near term, it would “lower and bring forward the expected peak in CPI inflation. This should restrain expectations of above-target inflation further ahead, but was not necessarily sufficient to do so alone, given inflation would still be very high for several months”. Those in the 75 bp camp were more in the front-loading mindset: “Faster policy tightening now would help to bring inflation back to the target sustainably in the medium term, and reduce the risks of a more extended and costly tightening cycle later." With that in mind, the BoE would have to build in a bigger rate hike, which would see the majority shift over to the 75 bp camp.

The extra oomph from Chancellor Kwarteng’s £161 bln package (biggest tax cuts since 1972) will add £60 bln per year to borrowing. Our Stephen Gallo, European Head of FX Strategy, notes that the additional spending “brings the current expected total for net issuance to a little under £200 bln (£194 bln). To put this into perspective, net gilt issuance before redemptions was £98.4 bln during the 2018/2019 year (the last FY before any impact of the pandemic might have been picked up in the data. For the same year (18/19), net gilt issuance after redemptions was just £32 bln, based on data pulled directly from the DMO’s website”.

The financial market reaction to this mini-budget was harsh: the GBP plunged below $1.10, the lowest since March 1985, and there was a massive sell-off in Gilts (2-year yields surged 45 bps, and 33 bps for 10-years). Near four-decade high inflation and massive fiscal stimulus is not a good combination.

Good luck PM Truss.