Nostalgia hunters may have had some reminders from the seventies this week, with a slumping currency, a finger-wagging from the IMF and rising gilt yields. Do the similarities end there?
- The Bank of England has been forced to intervene to half rising bond yields and a slide in sterling.
- Central banks intervening to mitigate the damage done by the government is not a good look
- Only a brave investors would take on UK assets at this moment, in spite of the ‘blood on the streets’
It’s been quite a week in UK financial markets. The impact of the mini-budget turned out to be anything but small, with gilt yields rising and a slump in the pound. After it looked like a number of pension funds might go bust, the Bank of England finally intervened, announcing a short-term bond buying programme to stabilise markets.
There are two possible options: the Chancellor decided to take the risk, knowing that the Bank of England would be forced to intervene, or the incoming government significantly underestimated the response of markets to its as-yet un-costed round of tax cuts and spending plans. Either option suggests a devil-may-care approach to fiscal management that won’t sit well with investors.
It is clear that the Bank of England had little choice but to intervene. Jim Leaviss, CIO of public fixed income at M&G Investments said: “What could the Bank do? They were frightened that this could become a systemic problem (‘a material risk’) for the UK economy - a financial stability issue. They have not talked about the impact of higher yields on economic activity, but obviously higher gilt yields feed through into higher borrowing costs for households and businesses too.”
What happens next? There are clamours to for parliament to assemble to discuss the crisis. It isn’t due to sit until 11 October, once party conference season is over. The Chancellor has said he will announce plans to reduce the fiscal deficit in November, but it seems unlikely that markets will wait that long. In the interim, the UK has looser monetary policy, with gilt sales from the Bank’s balance sheet – Quantitative Tightening – have been postponed until the end of October. Perhaps this was the plan all along?
However, as Leaviss points out the Bank of England having to intervene to mitigate the damage done by the government is not a good look. The intervention of the IMF should also give the UK government pause for thought. It may believe it is fighting fiscal orthodoxy, but these are some big beasts to take on. Even if the government believes it is right, some conciliatory measures would have eased market tensions.
It is difficult to see what comes next. In normal times, a 4% gilt yield would look pretty appealing, as would other UK assets and the bravest investors will almost certainly be taking advantage of this ‘blood on the streets’ moment. However, there is still the worry that worse may be just around the corner.
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