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Germany worried about UK’s ‘major experiment’
The German government is concerned that Britain is conducting a ‘major’ experiment, by cutting taxes and boosting borrowing just as the central bank is raising interest rates.
German finance minister Christian Lindner raised doubts about the British government’s plans to accelerate spending while the central bank tightens policy to rein inflation.
In another sign of rising international concern, Lindner warned:
“In the UK, a major experiment is starting as the state simultaneously puts its foot on the gas while the central bank steps on the brakes,”
Speaking last night, at an event hosted by the Frankfurter Allgemeine Zeitung newspaper, Lindner suggested that it wouldn’t end well….
“I would say we wait for the results of this attempt and then draw the lessons.”
JP Morgan economist Allan Monks argues that Kwasi Kwarteng will need to reverse his strategy.
This can’t wait until chancellor lays out his medium-term fiscal plan on November 23rd, Monks warned (via Reuters).
Monks said the statements from Kwarteng, and the Bank of England, yesterday were “measured”….
“But there is still no clear sign that the source of the problem – the government’s fiscal strategy – is being reversed or reconsidered.
This will need to happen before November in order to avoid a much worse outcome for the economy.
Summers: crisis could drive pound below euro and dollar parity
Larry Summers, a former US Treasury secretary, has warned that the UK government’s ‘utterly irresponsible’ plans could drag the pound below parity against the euro, as well as the dollar.
Summers has heavily criticised chancellor Kwasi Kwarteng for undermining credibility by saying ‘incredible things’ about planning more tax cuts — those weekend comments pushed the pound to a record low of $1.0327 on Monday.
Summers says he was “very pessimistic about the consequences of utterly irresponsible UK policy on Friday,” but didn’t expect the markets to get so bad so quickly.
Summers also suggests the Bank of England should have taken more decisive action, rather than its ‘timid’ statement yesterday.
Summers says:
The first step in regaining credibility is not saying incredible things. I was surprised when the new chancellor spoke over the weekend of the need for even more tax cuts.
I cannot see how the BOE, knowing the government’s plans, decided to move so timidly.
Summers pointed to surging interest rates of long-dated British debt as a “hallmark of situations where credibility has been lost”.
“This happens most frequently in developing countries but happened with early Mitterrand before a U-turn, in the late Carter Administration before Volcker and with Lafontaine in Germany.”
Summers warns that there could be global consequences from a currency crisis in the pound, as it is a reserve currency.
The magnitude of Britain’s trade current account deficit underscores the seriousness of its challenges. My guess is that pound will find its way below parity with both the dollar and euro.
Currently the pound is trading at €1.12, having hit €1.08 in yesterday’s crash, the weakest since the end of 2020.
Here’s the full thread.
I was very pessimistic about the consequences of utterly irresponsible UK policy on Friday. But, I did not expect markets to get so bad so fast.
A strong tendency for long rates to go up as the currency goes down is a hallmark of situations where credibility has been lost.
— Lawrence H. Summers (@LHSummers) September 27, 2022
This happens most frequently in developing countries but happened with early Mitterrand before a U turn, in the late Carter Administration before Volcker and with Lafontaine in Germany.
— Lawrence H. Summers (@LHSummers) September 27, 2022
British credit default swaps still suggest negligible default probabilities, but they have risen very sharply. I cannot remember a G10 country with so much debt sustainability risk in its own currency.
— Lawrence H. Summers (@LHSummers) September 27, 2022
The first step in regaining credibility is not saying incredible things. I was surprised when the new chancellor spoke over the weekend of the need for even more tax cuts. I cannot see how the BOE, knowing the government’s plans, decided to move so timidly.
— Lawrence H. Summers (@LHSummers) September 27, 2022
The suggestions that seem to have emanated from the Bank of England that there is something anti- inflationary about unbounded energy subsidies are bizarre. Subsidies affect whether energy is paid for directly or through taxes now and in the future, not its ultimate cost.
— Lawrence H. Summers (@LHSummers) September 27, 2022
The magnitude of Britain’s trade current account deficit underscores the seriousness of its challenges. My guess is that pound will find its way below parity with both the dollar and euro.
— Lawrence H. Summers (@LHSummers) September 27, 2022
I would not be amazed if British short rates more than triple in the next two years and reach levels above 7 percent.
— Lawrence H. Summers (@LHSummers) September 27, 2022
I say this because US rates are now projected to approach 5 percent and Britain has much more serious inflation, is pursuing more aggressive fiscal expansion and has larger financing challenges.
— Lawrence H. Summers (@LHSummers) September 27, 2022
Financial crisis in Britain will affect London’s viability as a global financial center so there is the risk of a vicious cycle where volatility hurts the fundamentals, which in turn raises volatility.
— Lawrence H. Summers (@LHSummers) September 27, 2022
A currency crisis in a reserve currency could well have global consequences. I am surprised that we have heard nothing from the IMF.
— Lawrence H. Summers (@LHSummers) September 27, 2022
Some welcome relief in markets this morning: the pound strengthens against the dollar, up to $1.08…
and UK govt bond yields drop slightly, with the 10yr down from 4.2% to 4.1%.
Both still a LONG way away from where they were only last week.
But here’s hoping for a quieter day 🤞 pic.twitter.com/LFiH1uszOu— Ed Conway (@EdConwaySky) September 27, 2022
After two frantic days, the markets are somewhat calmer today.
Sterling is holding onto the $1.08 point against the US dollar, up a cent this morning, but still slightly below its close on Friday night after the initial shock of the mini-budget.
UK government borrowing costs are recovering a little too, after surging on Friday and Monday.
The yield, or interest rate, on short-dated two-year bonds has dipped by 0.13 percent to around 4.2% – still sharply higher than at the start of September (when it was 3%).
The slump in UK government bond prices has added to a grim year for sovereign debt.
Bank of America strategists have calculated that government bond markets are on course for the worst year since 1949, when Europe was rebuilding from the ruins of World War Two.
The breakdown in the UK gilt market will only exacerbate what’s likely gonna be the worst year for bond funds since anyone managing money in this asset class has been doing it.
Bonds have been absolutely smashed. pic.twitter.com/sd8AmTaRr3
— David Ingles (@DavidInglesTV) September 27, 2022
Full story: Kwasi Kwarteng to hold crisis meeting with bankers after pound plunges
Julia Kollewe
Kwasi Kwarteng is meeting with Britain’s top bankers and other senior City figures on Tuesday, in planned talks that are likely to turn into a crisis meeting after the sell-off of the pound and government bond market meltdown.
Banks emerged among the biggest beneficiaries of Friday’s mini-budget when the chancellor scrapped the EU banker bonus cap and the top 45% rate of income tax, cut stamp duty to prop up the housing market and trailed “an ambitious package of regulatory reforms” to be unveiled this autumn.
However, the announcement sent the pound and government bonds plunging, as the scale of the tax cuts, which overwhelmingly benefit the better-off, shocked markets and prompted worries about how they will be paid for.
Here’s the full story:
Market mayhem means balancing the books will be harder
The panicky market reaction to the mini budget means it will be harder for Kwasi Kwarteng to balance the books.
Resolution Foundation chief executive Torsten Bell warns it may mean £15bn of additional ‘tough choices’ (spending cuts, or tax rises).
Kwasi Kwarteng said yesterday he’ll announce how the government will get debt falling as a share of GDP in the medium-term, in November.
Bell told Sky News it will be tough.
“The world we are heading for is a bumpy few weeks. The Chancellor is now going to have quite a tough time because he has now set out plans to balance the books in November. That is going to be very hard.
“Actually balancing the books in November is going to be harder than it would have been to show you are balancing the books last week because higher interest rates will make it harder to do.
“You might need 15bn-worth of tough choices now that you didn’t need last Friday.”
Bell also explained that the markets don’t think the government’s plans are actually serious:
“In the end, lower taxes will mean worse public services, or other people’s taxes having to go up, and it is those choices and ducking those choices that markets are looking at and saying that is not what serious policy making looks like.”
The gilts sell-off with 10 year bonds yielding 4.2 %, and markets now expecting 6 %base rates ( implying mortgage rates 7.5 % +) has already killed off any stimulatory impact of the mini budget. Expect close to incredible spending cuts in November. Mad! And nobody voted for it
— Will Hutton (@williamnhutton) September 27, 2022
The slump in gilts now means it costs more for the UK to borrow than Italy and Greece, former BoE governor Charlie Bean adds.
He tells the Today Programme:
One fact to get your head round. It now costs the UK government to borrow… than Italy or Greece, who we’ve traditionally thought of as being, well not quite basket cases, but certainly weaker-performing sovereign entities.
This is true for five-year borrowing (Bean misspoke by saying 10 years – we’re not there yet).
Someone needs to check their maths. UK 10yrs are currently 4.08%. Italy is currently 4.61%.
— ForexFlow (@forexflowlive) September 27, 2022
Today, UK five-year gilts are trading at a yield of 4.3% – higher than Greece (4%), or Italy (4%), who were both gripped by the eurozone debt crisis a decade ago (here’s a liveblog from those dramatic days).
The slump in the pound, and the surge in bond yields does show that the financial markets are increasingly concerned about the direction of UK macroeconomic policy.
Unlike eurozone members, though, the UK sets its independent monetary policy – and prints its own currency.
The fall in the pound reflects fears that that UK’s current account deficit (measuring the flow of goods, services and investments in and out of the country) will balloon even wider – requiring an even weaker currency to bring it into line.
Toby Nangle, former global head of asset allocation at Columbia Threadneedle Investments, wrote a good piece about this in the FT.
Here’s a flavour:
The current account deficit is now forecast to average eight per cent of GDP in 2022 and 2023, according to Pantheon Macroeconomics, an independent research consultancy. Bank of England data going back to 1772 shows that this level of deficit has only been exceeded on three occasions, each of them during the second world war.
In simple terms, the British people have become poorer without enjoying the benefits of a more competitive currency that the textbooks promise. And they are more reliant than ever on the kindness of strangers.
The balance of payments crisis claim still sounds hyperbolic. After all, a weakening pound improves the country’s international investment position. And there is no obvious large overhang of borrowings in dollars that would raise the debt-to-GDP ratio if the pound falls.
But sterling has been increasingly at risk of losing its “developed market privilege”, which confers safe-haven status on your assets, increasing the state’s ability to run countercyclical monetary and fiscal policy.
NOOOI! Not you too Sir Charlie Bean?!?
“One thing to get your head around is that it costs the UK govt more to borrow than it does Italy or Greece … which are not quite basket-cases, but weaker performing sovn entities” @BBCr4today
— Toby Nangle (@toby_n) September 27, 2022
Charlie Bean adds that the government got the sequencing of its growth plan wrong.
It should have started with focusing on the structural reforms it wants to implement to lead to better growth, and preserved fiscal responsibility and ‘sound money’.
Then, if the growth bet delivered, you can do the tax cuts.
That’s exactly what Margaret Thatcher did, Bean explains – starting with fiscal consolidation, getting inflation down, then privatisations and structural reforms – and then only tax cutting at the end under Nigel Lawson.
Former deputy Bank governor: emergency meeting may have made sense
Former Bank of England Deputy Governor Charlie Bean has suggested that the BoE should have called an emergency meeting this week to tackle the sterling crisis.
Bean says that the Bank are rightly reluctant to have emergency meetings every time there’s turmoil in the financial markets.
But on this occasion, it might have made sense.
Speaking on Radio 4’s Today Programme, Bean explains:
“On this occasion if I had still been at the bank in my role as deputy governor I certainly would have been counselling the governor that I think this is one of those occasions where it might have made sense (to call a meeting),”
Bean adds, though, that the Bank would have needed to have taken action (by raising interest rates).
“The key thing is, if you call it, you have to take significant action.”
Bean adds that the lesson of these episodes, where a currency is weakening and longer-term interest rates are rising, is that “you go big and you go fast”.
⚠️ FORMER BOE DEPUTY GOVERNOR CHARLIE BEAN: IF YOU CALL AN EMERGENCY CENTRAL BANK MEETING, YOU HAVE TO TAKE SIGNIFICANT ACTION
– Reuters via https://t.co/ymHY6x3NYD
— PiQ (@PriapusIQ) September 27, 2022
The shock increase in UK government bond yields in the last few days is the equivalent of Queens Park Rangers beating Manchester United 5-0, says Mohamed El-Erian, chief economic adviser at Allianz.
El-Erian (a QPR fan), told the Today programme:
The move in yields, 100 basis points, up 25 basis points in two days is somewhere between unthinkable and unlikely.
It has happened, and now the economy is adjusting to it, and that is the concern.
[Today presenter Nick Robinson (a Man United fan) points out that 5-0 losses happens ‘rather too often these days’]
The next few days will be crucial in determining the impact of the crisis on mortgages, according to Julie-Ann Haines, chief executive of the Principality Building Society.
Haines told the Today Programme that there have been “very significant increases” in mortgate rates this year, adding an extra £3,000 to £4,000 to an average £250,000 mortgage.
What the markets do in the next 10 days is really quite important in determining quite how big the impact is.
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