Jeremy Hunt’s announcement of a new round of sterling and gilt sales should be considered a welcome development. The Bank of England’s (BoE) latest intervention in the UK government debt market is designed to address the concerns about financial stability and provide a bit of cover for investors. However, it’s not all good news for sterling, and there may be some choppy times ahead.
The Bank of England’s intervention is an attempt to stem the rise of the 30-year gilt yield, which has fallen by more than 100 basis points in the past two weeks, and to provide a bit of cover for the government to continue its aggressive fiscal programme. But in the short-term, this may have little to no impact on rates. And it’s likely that the government will be forced to borrow more to fund the economic programme, which may result in an increased supply of supply in the future.
The Office for Budget Responsibility (OBR) has labelled the UK as in a recession. In a recent report, the OBR predicts that GDP will contract by 1.4% in the next year, and that inflation will be at 10.1%, which is the highest annual rate of inflation for any G7 country. And while there’s no official data to back up this, the government has announced a series of spending cuts and tax increases. In addition, a new round of gilt and sterling sales should begin on October 31st. This will be the first time the Treasury and the Bank of England have worked together to counter rising prices.
The Bank of England has also announced that it will take action to fight inflation and increase interest rates. However, it’s a bit of a red herring and the only thing that’s really going to benefit from this is the equity markets. While UK government debt yields have soared, they’ve actually fallen in the past two weeks, and this should have a positive effect on equity investors. In the UK, the 10-year yield is close to two-month lows, and is priced in at a 50 basis point hike in the next central bank meeting. The BOE has also said that it will end its temporary purchase of government bonds on 14 October.
Despite the intervention, the Bank of England’s announcement is not likely to be greeted with the same level of enthusiasm as its previous QT operation, which started four months ago. While the BoE acknowledged that the gilt market is “distressed,” it’s not clear how much it can do. It’s likely that the government will be forced by the current situation to borrow more than it needs, but that’s not a problem that lenders will be able to easily solve. The solution is to shift the burden to energy companies. However, energy companies are unlikely to be able to raise money from banks at their 15 year average maturity.
The new prime minister, Liz Truss, has taken office and she’s inherited a crisis that isn’t getting any easier. Energy costs have risen sharply, and the government is in need of additional funds to meet its spending commitments. In the next two years, government bond sales are expected to double, and the government’s borrowing needs are likely to increase as well.