The Bank of England on Monday did precisely what you don’t want to do in a crisis: Speak up without demonstrating the necessary conviction.
It’s better to remain silent than to be audibly meek, a lesson Andrew Bailey may learn over the next several days after issuing an underwhelming statement amid a historic selloff in gilts and a record low for the pound.
The figure (below) depicts one of the more astounding moves you’ll ever see in a developed market asset.
The five-day jump in five-year UK yields isn’t just unprecedented. It’s unthinkable.
The statement began with boilerplate language. The BoE is “monitoring developments in financial markets very closely in light of the significant repricing of financial assets.” Apparently, the BoE was as bereft as everyone else when it came to describing the tumult. “Significant” seemed wholly insufficient.
In an apparent effort to observe decorum, Bailey said he “welcomed” the Truss government’s “commitment to sustainable economic growth.” Although he also mentioned “the role of the Office for Budget Responsibility” in assessing the “prospects for the economy and public finances,” I’d gently suggest that “welcome” was a poor choice of words for a growth plan the market so mercilessly panned.
Bailey did make an oblique reference to the possibility that Liz Truss’s plan will perpetuate and prolong the supply-demand mismatch behind the UK’s double-digit inflation problem, but the cautious wording suggested the BoE is loath to upset Truss. “The role of monetary policy is to ensure that demand does not get ahead of supply in a way that leads to more inflation over the medium-term,” Bailey said.
To be sure, his options are limited when it comes to pacifying markets without chancing blowback from Truss, who, prior to winning the leadership race, was openly critical of the BoE, blaming the bank for the UK’s inflation woes. But the UK is staring at an emerging market-style spiral. Decorum is irrelevant. The perception that the BoE feels pressure not to aggravate Truss is more blood in the water. If traders believe that, they’ll push the envelope. Hard.
It’s not just traders the bank needs to worry about. Public opinion fell further in the latest quarterly survey (figure below).
Respondents are asked to assess the way the bank is “doing its job to set interest rates to control inflation.” In May, the net satisfaction balance turned negative for the first time ever, at -3%. It fell to -7% in the latest survey, results from which were released earlier this month.
Bailey’s biggest mistake on Monday, though, may have been to cast doubt on the likelihood of an inter-meeting rate hike. “As the MPC has made clear, it will make a full assessment at its next scheduled meeting of the impact on demand and inflation from the Government’s announcements, and the fall in sterling, and act accordingly,” he said, before insisting that “the MPC will not hesitate to change interest rates by as much as needed to return inflation to the 2% target sustainably in the medium-term, in line with its remit.”
The problem with that latter assurance is that although it addresses market concerns about the MPC’s willingness to deliver draconian rate hikes if necessary, it was undermined by the reference to the “next scheduled meeting” in the preceding sentence. Although the statement doesn’t unequivocally rule out an emergency hike, it appeared to suggest the BoE thinks such a move is unlikely. Markets had priced some chance of a hike as soon as Monday.
Markets may consider Bailey’s remarks weak-willed and, fairly or not, some traders will probably view the MPC as unwilling to explicitly acknowledge the risks posed by Truss’s plan or, at the least, unwilling to present them as risks. There’s a difference between characterizing something as a “risk” to forecasts, and using the term “risk” in a more general way. Truss’s plan is risky in an absolute sense. Or at least that’s what markets think, and that’s all that matters.
Irrespective of anyone’s personal opinion of Truss and her economic agenda, markets see it as an opportunity to attack the country’s currency and repudiate UK government bonds. Bailey should drop the cautious language about the BoE’s “role” and “remit,” in favor of an unequivocal commitment to safeguarding the pound and preserving the government’s capacity to borrow at levels consistent with a reserve currency nation. That’s the biggest favor he can do Truss.
Read more: Analysts Weigh In On UK ‘Calamity’