Εβδομαδιαία Επισκόπηση: Διεθνής Οικονομία & Αγορές, 27/09/22
The Bank of England will carry out unlimited UK Government bond purchases, with British Pound remaining under pressure due to large unfunded tax cut plans
Key Takeaways
Gilt yields have surged and the British pound has depreciated sharply, in order to compensate for the higher United Kingdom’s policy premium, as the unfunded fiscal easing leads to balance of payments concerns.
In an emergency decision (Wednesday 28th), however, the Bank of England announced that will purchase long-dated UK government bonds from September 28th to October 14th, on whatever scale is necessary, in order to restore orderly market conditions in UK financial assets. Gilt yields initially declined following the announcement (see intra-day graph below), albeit in the medium-term, the decision reveals the risk of fiscal dominance.
The Bank of England has postponed, but not cancelled, the beginning of gilt sale operations that were due to commence next week. The Bank of England, on Thursday 22nd, has announced the reduction of gilt holdings by £80bn in the next 12 months, to £758bn (31% of GDP), including via sales. Since March 2022, a reduction by £37 bn has taken place, solely via non-reinvestment of maturing assets (passive quantitative tightening).
The Bank of England may need to increase its policy rate significantly higher than expected, in order to offset higher inflation risks emanating from fiscal expansion and GBP’s rapid depreciation. Investors’ pricing based on sterling overnight index swap rates suggests a Bank Rate of 6% one-year ahead, versus 4.6% a week ago. The BoE has increased its policy interest rate by +50 bps to 2.25% in the past week (Fed: +75 bps, ECB: +75 bps)
On Friday 23rd, a new fiscal package was announced (Growth Plan) which includes broad based reductions and cancellations of planned increases in taxes and social contributions. Estimates from UK’s HM Treasury place the overall cost at £161bn (6.6% of GDP) over the next 5 years.
The latest package comes on top of the one announced earlier in the month (Energy Price Guarantee) to alleviate households’ and corporations’ burden from high energy bills, with the HM Treasury foreseeing a £60bn cost in fiscal year 2022/23 alone (April 2022 to March 2023). Independent estimates for the full life period of the package, through fiscal year 2024/25, place the total at c. £150bn (or 6% of GDP).
The HM Treasury has already revised up the Net Financing Requirement (NFR) in fiscal year 2022-23, from £162bn in April 2022 to £234.1 bn, to be financed by additional government bond (gilt) sales of £62bn and net Treasury bill sales for debt management purposes of £10bn. Note that UK net debt as percent of GDP was expected, before the latest fiscal expansion, to hover around 96% of GDP in fiscal year 2022/23 and 94% in fiscal year 2023/24, from 81% before the pandemic.
UK Government bond yields have increased sharply by 101 bps since September 22nd to 4.51%, a 14-year high, in view of expectations for significantly higher government borrowing, while their short-term peers (2Y) have surged by 112 bps to 4.65%. At the same time, an acute depreciation of the British Pound took place, briefly hitting intra-day a record low of GBP/USD 1.04 on September 26th, before partly recovering towards GBP/USD 1.08 (-7% MtD and -20% YtD).
Key Takeaways
Gilt yields have surged and the British pound has depreciated sharply, in order to compensate for the higher United Kingdom’s policy premium, as the unfunded fiscal easing leads to balance of payments concerns.
In an emergency decision (Wednesday 28th), however, the Bank of England announced that will purchase long-dated UK government bonds from September 28th to October 14th, on whatever scale is necessary, in order to restore orderly market conditions in UK financial assets. Gilt yields initially declined following the announcement (see intra-day graph below), albeit in the medium-term, the decision reveals the risk of fiscal dominance.
The Bank of England has postponed, but not cancelled, the beginning of gilt sale operations that were due to commence next week. The Bank of England, on Thursday 22nd, has announced the reduction of gilt holdings by £80bn in the next 12 months, to £758bn (31% of GDP), including via sales. Since March 2022, a reduction by £37 bn has taken place, solely via non-reinvestment of maturing assets (passive quantitative tightening).
The Bank of England may need to increase its policy rate significantly higher than expected, in order to offset higher inflation risks emanating from fiscal expansion and GBP’s rapid depreciation. Investors’ pricing based on sterling overnight index swap rates suggests a Bank Rate of 6% one-year ahead, versus 4.6% a week ago. The BoE has increased its policy interest rate by +50 bps to 2.25% in the past week (Fed: +75 bps, ECB: +75 bps)
On Friday 23rd, a new fiscal package was announced (Growth Plan) which includes broad based reductions and cancellations of planned increases in taxes and social contributions. Estimates from UK’s HM Treasury place the overall cost at £161bn (6.6% of GDP) over the next 5 years.
The latest package comes on top of the one announced earlier in the month (Energy Price Guarantee) to alleviate households’ and corporations’ burden from high energy bills, with the HM Treasury foreseeing a £60bn cost in fiscal year 2022/23 alone (April 2022 to March 2023). Independent estimates for the full life period of the package, through fiscal year 2024/25, place the total at c. £150bn (or 6% of GDP).
The HM Treasury has already revised up the Net Financing Requirement (NFR) in fiscal year 2022-23, from £162bn in April 2022 to £234.1 bn, to be financed by additional government bond (gilt) sales of £62bn and net Treasury bill sales for debt management purposes of £10bn. Note that UK net debt as percent of GDP was expected, before the latest fiscal expansion, to hover around 96% of GDP in fiscal year 2022/23 and 94% in fiscal year 2023/24, from 81% before the pandemic.
UK Government bond yields have increased sharply by 101 bps since September 22nd to 4.51%, a 14-year high, in view of expectations for significantly higher government borrowing, while their short-term peers (2Y) have surged by 112 bps to 4.65%. At the same time, an acute depreciation of the British Pound took place, briefly hitting intra-day a record low of GBP/USD 1.04 on September 26th, before partly recovering towards GBP/USD 1.08 (-7% MtD and -20% YtD).