The headlines around the UK’s ongoing economic crisis and attendant policy debacle were a sight to behold on Wednesday.
One somewhat misleading, but accidentally apt, title read, “Kwarteng Says Bank of England Handling UK ‘Very Effectively’.”
Kwasi Kwarteng didn’t actually say that Andrew Bailey is currently in charge of the UK, but it certainly feels like the central bank is a “handler” right now — a technocratic caretaker, whose patience with what the market plainly believes is gross fiscal ineptitude may be running very thin.
It’s possible that Bailey’s “Whatever it takes… until Friday” messaging actually wasn’t a tone deaf, “drop dead” direct warning to UK pension funds, but rather an indirect warning to Liz Truss and Kwarteng. The BoE might be attempting to force a fiscal U-turn, by throwing Truss’s budget to the bond vigilantes and the FX wolves.
According to the Financial Times, the BoE “has signaled privately to bankers that it could extend its emergency bond-buying program past Friday’s deadline.” The FT cited a trio of sources, one of whom said “They told us that they were watching the LDI managers closely to see whether they had managed to generate enough liquidity for their clients to cope with margin calls and would decide whether to extend the facility on Thursday or Friday.”
Needless to say, the conflicting headlines whipsawed UK assets. As SPI Asset Management’s Stephen Innes put it, it’s getting “frustrating to write market commentary about” sterling and gilts. The abject confusion was reflected in the amusing juxtaposition between the following two headlines, which were situated side by side Wednesday: “‘The Bears Will Have It’: Bailey Sets Pound, Gilts for More Pain”; “Pound Rebounds on Report BOE Offers to Extend Bond Purchases.”
It’s so bad, Bloomberg noted, that one UK lender is nudging bondholders into new notes at a 100bps premium over its existing perpetual bonds, rather than call them and brave the dark waters of a sterling market that’s seen no new issuance since Kwarteng’s botched budget unveil sparked unprecedented volatility in UK rates late last month.
The foreboding news was unrelenting. Also on Wednesday, ONS said the UK economy shrank in August for the second time in three months (figure below). Consensus expected a flat print.
Kwarteng blamed Vladimir Putin, who he called a barbarian. Rachel Reeves pounced. “This is a Tory crisis, made in Downing Street and paid for by working people,” the shadow Chancellor said. “Mortgage costs are soaring leaving families worrying about making ends meet. Borrowing costs are up. Living standards down. And we are forecast to have the lowest growth in the G-7 over the next two years.”
Apparently, the economy would’ve needed to expand 1.1% last month in order for the UK to avoid a downturn. Needless to say, that’s highly unlikely, particularly given the long mourning period for the Queen, whose tragic passing now seems even more inauspicious than it did on September 8.
Insult to injury Wednesday was the BoE’s quarterly Financial Policy Summary which included, among other dubious quotable passages, the following excerpts:
In late September, UK financial assets saw further significant repricing, particularly affecting long-dated UK government debt. The rapid and unprecedented increase in yields exposed vulnerabilities associated with the leveraged liability-driven investment (LDI) funds in which many defined benefit pension schemes invest. This led to a vicious spiral of collateral calls and forced gilt sales that risked leading to further market dysfunction, creating a material risk to UK financial stability. This would have led to an unwarranted tightening of financing conditions and a reduction in the flow of credit to households and businesses.
The continued rise in living costs and interest rates will put increased pressure on UK household finances in coming months and make households more vulnerable to shocks. Overnight swap rates, which feed directly into mortgage interest rates, were, at the time of the FPC Policy meeting, priced to peak at around 6%. Assuming rates follow this market-implied path, the share of households with high cost-of-living adjusted mortgage debt-servicing ratios would increase by end-2023 to around the peak levels reached ahead of the global financial crisis (GFC).
Higher input costs and lower demand will weigh on earnings for many businesses, especially those in sectors with large exposure to energy and fuel prices, or who provide non-essential household goods and services. This pressure on corporate earnings, combined with the rising cost of credit, will reduce companies’ ability to service their debts, which is likely to lead to some business failures.
Finally, the BoE was compelled to respond to the FT‘s reporting, which the bank didn’t exactly “deny,” but pushed back on all the same.
“As the Bank has made clear from the outset, its temporary and targeted purchases of gilts will end on October 14,” a spokesperson said, in an emailed statement to Bloomberg. “The Governor confirmed this position yesterday, and it has been made absolutely clear in contact with the banks at senior levels.”
Forgive me, but this is an emerging market. And it’s totally untenable. As Bloomberg’s Mark Cranfield put it Wednesday (and I’m paraphrasing), you can’t have total chaos in a major developed market.
Now Kwarteng is saying the BOE will be to blame if the pound falls next week . . .