The Bank of England went into full financial crisis mode on Wednesday, rushing out with an announcement that the central bank would restart its money printing presses at “any scale needed”, later confirming that it planned up to £65 billion in new quantitative easing. to plan.
Ministers have tried to say the recent financial turmoil was global, but no one in the markets doubted that the UK’s troubles were the result of £45bn in unfunded tax cuts in Chancellor Kwasi Kwarteng’s ‘mini’ budget last year. Friday.
The decline in sterling’s value against the US dollar and the spike in government bond yields since Kwarteng’s fiscal statement has put Prime Minister Liz Truss’ economic policy in acute difficulty, and the latest QE measure by the BoE raised even more questions.
During her campaign for Conservative Party leadership, Truss blamed the BoE’s post-financial crisis QE program — printing money to buy £875 billion in government bonds to boost the economy — of causing inflation.
“Part of the inflation has been caused by an increase in the money supply,” Truss said in July, but in September her administration had authorized the BoE to restart the money printing presses.
The BoE said the goal of its latest purchase of long-term government bonds was to restore financial stability rather than boost inflation. The central bank tried to avoid an artificial spike in government bond yields over 20 years, which jeopardized the solvency of pension funds.
But analysts have expressed concern about how Kwarteng and the BoE appear to be pulling in opposite directions — through the chancellor’s unfunded tax cuts to boost demand and the central bank’s moves to raise interest rates to mitigate the high. curb inflation.
Paul Hollingsworth, economist at BNP Paribas, said: “It’s hard to seem coordinated when fiscal policy has its foot on the accelerator and monetary policy on the brakes.”
The BoE’s position has been further complicated by the way its latest government bond purchase action is taking place at the same time as the BoE is also trying to tighten monetary policy, in part by selling government bonds built up under its QE program for after 2009. The new purchase of government bonds opens the central bank to accusations that it is fueling inflation.
Bethany Payne, bond portfolio manager at Janus Henderson Investors, said: “The Bank of England is generously offering to buy long-term government bonds starting today. That’s a complete turnaround from their announcement last Thursday where they confirmed that gilt sales would continue. , from Monday 3 October.”
With these contradictions undermining the credibility of British economic policy, the big question is what comes next.
The BoE was adamant on Wednesday that it would stick to its current schedule for interest rate decisions, with the next meeting of the central bank’s Monetary Policy Committee scheduled for Nov. 3.
Gerard Lyons, chief economic strategist at Netwealth, who advised Truss informally, said that if possible, the BoE “should avoid making decisions between meetings on tariffs”.
This prevented a sense of panic, and calibrating the scale of tariff increases during an MPC emergency meeting would be difficult, he added.
The BoE also emphasized that it wanted to end its latest money-printing effort quickly: by October 14. She said the asset purchases would be “strictly time-limited,” although BoE officials also noted that holding the intervention temporarily relied on a “signalling effect.”
Once financial markets could see the magnitude of the intervention the BoE was undertaking, central bank officials expected the turbulence to ease and buyers of long-term government bonds to return, even if yields remained much higher than in recent weeks.
Kallum Pickering, an economist at Berenberg Bank, said the BoE message was, “Don’t fight a central bank in its own currency” because you could lose a lot of money.
However, according to many economists, the BoE’s deeper problem was that, by bailing out ministers, the central bank seemed willing to print money to fund the government, something it had previously promised never to do because it was inflationary.
They described the process as “fiscal dominance” because the Treasury would be in control with the result that inflation could spiral out of control.
Allan Monks, economist at JPMorgan, said: “The optics are not favorable for the bank and will inevitably lead to discussions about fiscal dominance and monetary financing of the bank. [budget] shortage.”
“Reducing bond purchases in the name of market forces may be justified; however, this policy action is also creating the specter of monetary financing, which could increase market sensitivity and force a change of approach,” said Robert Gilhooly, senior economist at Abrdn.
At the Treasury, Kwarteng, who will deliver a keynote speech at the Conservative Party’s conference on Monday, continued to come under pressure to clarify how his unfunded tax cuts can coexist with sustainable public finances. The IMF launched a sharp attack on Kwarteng’s tax cuts on Tuesday, urging the government to “reconsider” the plan as the “untargeted” measures threatened to fuel rising inflation.
David Page, head of macro research at Axa Investment Managers, said: “Obviously the latest government policies to ignore economic realities are very damaging politically, but they also turn out to be economically damaging.”
He added that until his speech next week, the chancellor had “a chance to turn things around”. [on his mini-Budget tax cuts and a] Refusal to change course is likely to increase pressure on UK financial markets and exacerbate the longer-term economic damage.”
Truss and Kwarteng have so far refused to accept a U-turn. While financial markets, the IMF and some Conservative MPs would favor a reversal of the Chancellor’s tax cuts, this seems the least likely path at the moment.