UK ‘Mixes Uppers With Downers’ In Wild Policy Debacle

A glaring policy disparity is emerging in the UK, and I don’t just mean between Andrew Bailey’s rate hikes and Liz Truss’s expansionary fiscal agenda.

On Tuesday, the Bank of England was forced to expand the scope of its “temporary” bond-buying scheme aimed at averting a meltdown in the UK pension complex. In my opinion (and I’m hardly alone), the BoE won’t be able to fully step away anytime soon, let alone start active gilt-selling later this month.

The expanded BoE gilt backstop came amid “good” UK labor market data, with the scare quotes there to denote that we’re operating in a truly brutal “good news is bad news” environment.

The UK unemployment rate fell to a 48-year-low during the three-month period ended in August (figure below), as workers exited the labor force at an unprecedented rate.

Kwasi Kwarteng, who should probably just stop talking, because every soundbite is a punchline, called the figures evidence that the UK economy is “resilient.” That may be a semblance of true, but the figures also suggest the labor market is the tightest in modern history, which, in turn, is inflationary.

The last thing Kwarteng needs at a time when the market is convinced his fiscal plan is likely to embed inflation in the economy over the longer-term (even as the energy cap alleviates the strain associated with the anomalous surge in European gas and power prices in the near-term), is evidence of acute labor shortages.

Wage growth was 5.4% excluding bonuses, which ONS helpfully noted was “the strongest growth in regular pay seen outside of the pandemic period.” So, a record, sans COVID. Average regular pay growth was 6.2% for the private sector, also an ex-COVID record, and, crucially, the gap between pay growth for private and public sector employees was the widest ever outside of the pandemic distortions, at more than four full percentage points (figure below).

If that ravine isn’t a reason to strike (if you’re a government employee), then I don’t know what is. Additional work stoppages and associated pay concessions raise the risk of a wage-price spiral.

The bad news for private sector workers (i.e., the people who are at least seeing large gains in compensation) is that inflation in the UK is near double-digits. So, even if your total pay is growing 6% (the bonus-inclusive print for last quarter), you’re still seeing your real earnings eroded at an alarming rate (figure below).

More than a quarter million workers became inactive during the period, the quickest pace of inactivity growth on record in data going back 52 years.

All of that is inflationary, and when taken in conjunction with the demand construction (as opposed to demand destruction) policies adopted by Truss, it’s likely to stoke (more) calls for huge rate hikes from the BoE.

Set against the bank’s bond-buying, and considered with what I believe to be the distinct possibility that ongoing bond purchases will be necessary, the stage is set for the BoE to either suspend QT plans, or even re-launch QE in order to avert market chaos predicated on the Truss growth plan, while hiking rates in massive increments as a result of the projected economic impact of that same growth plan.

“Mind you, in the background today we had positive UK labor market data at the same time that the new government remains committed to unfunded tax cuts, all of which keeps pressure on the ‘sole inflation mandate’ BoE to keep pushing ahead with tightening [while] simultaneously being forced to expand ’emergency’ bond purchases,” Nomura’s Charlie McElligott wrote. “So here we are, with the BoE mixing ‘uppers’ with their ‘downers,’ drinking Red Bull and vodka as they simultaneously hit the gas and brakes in chaotic fashion.”