The Bank of England stumbles again, this time in the bond market

Today it is the turn of the UK to take centre stage and we can open by in an accident of chance start by looking at things via the Bank of England. I have been pointing out for several weeks that this time around its job was simple, to defend the UK Pound. But iy would appear that even such a simple message is too much for it to comprehend.

At its meeting ending on 21 September 2022, the MPC voted to increase Bank Rate by 0.5 percentage points, to 2.25%. Five members voted to raise Bank Rate by 0.5 percentage points, three members preferred to increase Bank Rate by 0.75 percentage points, to 2.5%, and one member preferred to increase Bank Rate by 0.25 percentage points, to 2%.

Whilst ordinarily I would welcome a little divergence this was not the time for it as we see that only a third of the members got the currency memo and voted for 0.75% to match the US Federal Reserve. Actually one of them may not have done.

BOE Monetary Policy Committee Haskel: I Do Not Worry That Much About Sterling ( @PriapusIQ)

That is really rather troubling when it is part of its job and the US Dollar is rebounding around the world like a wrecking ball. Looking at the other side of the coin it is hard to know where to start with this from the newest member Swati Dhingra

One member preferred a 0.25 percentage point increase in Bank Rate to 2% at this meeting.

She appears to have missed both the currency crisis and the surge in inflation which do not seem to have reached her Ivory Tower. Someone replied to me on social media that she was “world class” which I think merits an entry in my financial lexicon for these times.

Bond Sales

I have warned for many years that the Bank of England plans for what has become called Quantitative Tightening or if you prefer reverse-QE were rather stupid. This is because under it you would find that the largest holder of UK bonds would be selling into a falling market. What could go wrong?

Even worse we all know that the UK will announce a lot more borrowing today of the order of £150 billion. So now was even less likely to be a good time for the Bank of England to start QT. And yet we got this.

all members of the Committee agreed at this meeting that the Bank of England should reduce the stock of
UK government bond purchases, financed by the issuance of central bank reserves, by an amount of £80 billion over the next twelve months, comprising both maturing gilts
and gilt sales, to a total of £758 billion.

We can look at the situation with a wider context. Yesterday the yield for the US ten-year rose by 0.2% to 3.7% so bond markets generally were in decline and in fact not far off a rout. That is exactly the wrong environment to be selling bonds into. If we now look at the UK we see that the UK ten-year yield has doubled since the 2nd of August when it was 1.75% as opposed to the 3.5% overnight.

We are in fact seeing a serious problem with QE which again is something I have warned about over time as it was never a free lunch.The Bank of England pays Bank Rate on it so is now paying 2.25%. You do not need to take my word for  it because rumours of a change in the rules give it away.From Bloomberg.

UK Prime Minister Liz Truss’s new government has looked at changing the Bank of England’s money-printing program to save the UK taxpayer billions of pounds at a time when the public finances are under increasing strain.
Under the option, interest paid on some deposits held by commercial lenders at the BOE would be scrapped, potentially saving more than £10 billion a year, based on calculations with the benchmark interest rate at 2.5%.

Is this why the Bank of England insiders limited their votes to give us a 2.25% Bank Rate?

Once the BOE’s benchmark interest rate is around 2.25%, the interest paid on reserves will be greater than the income from gilts and, under the QE indemnity with the Treasury, the government will start transferring funds to the BOE.

This is a generic iissue by the way and I note that others have been catching up with my warnings in this area. Let me illustrate from a land down under.

But one result of the change in the Bank’s balance sheet is that the Bank will report a substantial accounting loss in its 2021/22 annual accounts and, as a consequence, negative equity. ( Reserve Bank of Australia)

Okay so how much?

Over the past year, valuation losses on the Bank’s holdings of domestic bonds due to the rise in bond yields were around $40 billion. In addition, because we purchased many of these bonds at a price higher than their face value, the amount of this ‘premium’ will also be recorded as a loss over the life of the bond.[5] Over the past year, this accounts for a further $5 billion valuation loss.

So some 45 billion Aussie Dollars. Actually it will be even more now because in the subsequent couple of days Australian bonds have also seen rising yields of around 0.2%.

The Mini Budget

Everybody knew that the UK was going to be borrowing quite a bit more after today’s Mini Budget. Many of the plans were leaked so we had a pretty good idea although the ending of the 45 pence income tax rate was a bit of a rabbit out of the hat. For our purposes we got some more detail on the extra borrowing.

The Treasury said it would ask the Debt Management Office to raise an additional £72bn in the current financial year, revising the total upwards from £161bn in April to £234bn in September. ( Financial Times)

The extra borrowing combined with the expectation of sales from the Bank of England has put the skids under the UK bond market. Those looking at new mortgages will be concerned to see the UK five-year yield reach 4%. Some of this is an initial panic but the Bank of England has got this all wrong and looks incompetent when as I pointed out earlier the new government was known to be a tax-cutting one.

One point I will make is that those higher mortgage rates ( I use the five-year yield as a leading indicator) will rather undermine this.

We’re cutting Stamp Duty Land Tax which will help more people to move, promote residential investment and boost first-time ownership. ( HM Treasury)

Our political class seem unable to grasp why first-time buyers always need “Help”

Comment

This is a big event in fiscal terms and we have as a theme charted the changes here from perceived austerity being in fashion to now where the UK government looks to be a clear fan of fiscal expansionism. Actually I think the help for energy bills was inevitable and other countries will do the same. The real issue to my mind is the ongoing failure to address a major cause of our problems which is the supply of energy. Our political class chant a mantra about wind power when as I type this it is producing a mere 2 GW this morning.

A lot has been made about there being no forecasts from the Office for Budget Responsibility today. I am much less bothered about that because the first rule of OBR Club is that the OBR is always wrong. Also if it is independent why can it not produce its own forecasts? Also of the 3 members of its Responsibility Committee 2 are alumni of HM Treasury so we are being taken for fools with the “independent” line and we should scrap it and save the money.

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42 thoughts on “The Bank of England stumbles again, this time in the bond market

  1. Hi Shaun,

    How can the BoE defend Sterling when the current government is hell bent on winning the race to the bottom?

    I can appreciate that you try to keep politics out of economics, but Tory levelling-up (sic) agenda means they are inherently incestuous.

    • Sterling now $1.13 the mini budget turned out to be a maxi if you consider 40% tax tax rate.

      Yet again the rich get richer but the budget inflationary and we will pay for this which higher imports, Danny Blanchflower was right on shorting sterling albeit I wasn’t sure which currency.

      The market doesn’t like what Truss is going and both footsie 100 and 250 down circa 1.5%.

      A couple of retailers falling to new lows BooHoo and HUT group.

      Then we have cut ih stamp duty which may stimulate house marktet, but we risk a house market crash later on because INTEREST RATES WILL GO UP FASTER AND STAY UP LONGER.

        • Hi Peter I am so glad you are feeling much better.
          I agree with much that you say but it is not surprizing that at shares over here a falling
          as in USA shares have fallen heavily and the future markets indicating more falls today.
          A lot of low growth dividend payers sure to fall further as safe bonds are paying so much.
          ICE Brent Crude much lower in response.

          • Some analysts are now forecasting the BOE will raise rates 1% in November

            https://www.bbc.co.uk/news/business-63009173

            Truss thinks the financial easing through tax cuts will stimulate growth but the rise in borrowings will increase borrowing costs and send the £ plumeting and in turn increase imported inflation. this is not prudent economics.

            What could happen is we see another boom and bust.

            We are already seeing a financial crisis with the £ falling v the $ and even risk some of our UK companies being taken over by US private equity.

            The market has no faith in Truss economics and its a budget for the rich.

            She is also forcing the lower paid to have 2 and 3 jobs the working class working their buts off to make the rich get ever richer.

            But these things can have a nasty sting in the tail and bite back later on if the UK economy collapses fro poor fiscal policy.

    • They clearly aren’t trying to defend sterling are they? It is down 2% today against the dollar, the fact that sterling was already weaker than most major currencies meant that yesterday the BofE needed to a to a minimum raise rates by 0.75%, anything less and it was a clear signal to the markets that it wasn’t seroius about it and was happy for it to fall further, that is why I kept predicting 0.5% on here over the last few weeks -that’s why I firmly believe they are trying to deliberately destroy sterling.

      However the weakness of the pound has also been exarcerbated by the proposed policies of the incoming Truss, and today the announcement of these has opened the trapdoor on sterling. If they were serious, 1.0% should have been yesterdays increase.Normally fx trading should be like watching two snails playing snooker – very small moves, todays fall of currently 2% is catastrophic and shows the treason I regularly mention, to be evident in everything the government and BofE are doing, this is deliberate, no one could be this incompetent.The people implementing these policies are, those telling them what to do know exactly what they are doing.

      Perhaps I should clarify that last statement, I think Truss IS totally incompetent and clueless about economics, finance and markets and has been installed for this very reason to follow orders by those who have an agenda to destroy our country, otherwise she wouldn’t have been allowed within a hundred miles of 10 Downing Street. This policy of cutting taxes during a period of high inflation is known to make inflation WORSE – FACT, Anthony Barber did just that in 1970 when cutting taxes during very high inflation in a “dash for growth” just like today. Lending increased almost NINETEEN FOLD AND GOVERMENT BORROWING SOARED, Sterling plunged naturally but by 1975 inflation was falling in other countries but here it was in the mid twenty percents the same as during WWI to give context. Barber was also totally incompetent and Harold Wilson on hearing of his appointment said it showed at least Edward Heath had a sense of humour.

      So how is todays appointment of Truss and adoption of the exact same policies that caused a masive devaluation of sterling likely to produce a different resutl? I’ll let you decide, the number of coincidences make this yet another example of the forces behind the scenes deliberately destroying us.

      As I pointed out yesterday the government borrowings and tax cuts at the moment are highly inflationary as the economy is at full capacity and unemployment is very low, but they are also trying to sell gilts to pay for this at the same time as doing QT – selling off the vast quantity acquired during the covid panic thus driving up the rate of interest the new debt has to be issued at, causing the taxpayer the double whammy of maximum losses.

      Even perma bears like Albert Edwards of SocGen can get totally the wrong end off the stick regarding the Uk government and the BofE in this article via Zerohedge, he predicts the government will tighten further and do more QT, today’s events make that prediction totally useless.There is even a mention of the dreaded word “brave” from Yes Minister so often referred to on here by Shaun.

      The yield on the 5 year gilt which is a good indicator for 5 year fixed rate mortgages today exploded to 4.1% – nearly 4% higher than just over a year ago, all those that refinanced their mortgage then are in for a big shock in few years time.

      The figures above are from a Times article linked blow, but I think you have to have a subscription to read it.

      https://www.zerohedge.com/markets/albert-edwards-ice-age-over-replaced-great-melt-and-crushing-beta-drought

      https://www.thetimes.co.uk/article/history-tells-us-tax-cuts-might-be-worst-way-to-tame-inflation-rmc9567pk
      .

      • “They clearly aren’t trying to defend sterling are they? It is down 2% today against the dollar, the fact that sterling was already weaker than most major currencies meant that yesterday the BofE needed to a to a minimum raise rates by 0.75%, anything less and it was a clear signal to the markets that it wasn’t seroius about it and was happy for it to fall further, that is why I kept predicting 0.5% on here over the last few weeks -that’s why I firmly believe they are trying to deliberately destroy sterling.”

        Sterling now currently down 3.2% this is a dissaster.

        What this meansd is the BOE needs to raise rates far more going forward. Sterling now lost over 17% compared to a year ago.

        If I was a US private equity I would be looking at bidding for some UK companies and this isn’t good for the UK in the longer term.

        As for destroying sterling I don’t think they are thinking that (GOV) but foolishly not realizing if they dont act prudently the markets would destroy sterling.

  2. It’s easy to see where this heading Singapore on Thames here we come. I predict a flat tax in the next budget proper, you heard it here first. I am unsure how much scrapping the 45p rate will help with levelling up as the majority of higher rate tax payers live in London and the South East. This is nothing new it’s an economic strategy called boom and bust. The NHS and BBC are doomed unless these maniacs are stopped.

    The following is *not* investment advice I took out a binary option on the FTSE falling below 7115 so I’ve cleaned up thank you very much. I wish In had the nerve to bet on the $ and Euro reacing parity but I’ll leave that to other brave souls. Maybe the plan is so crazt it’ll work but I doubt it.

    • bill,

      “This is nothing new it’s an economic strategy called boom and bust.”

      A high risk gamble which could end in boom or bust.

      But as worrying is the low rate tax payers will only save something like a few hundred quid but someone over £150k will save a few thousand. The low rate tax payers get the saving eaten up with inflation and the high rate tax payer may decide to spend more on a holiday in Dubia. How can that assist the economy in the UK ?

    • Hi bill40

      I found it funny too. I had been thinking along those line for the foreign exchange intervention from the Bank of Japan but had not come up with much. It must have been grateful that we took centre stage today although it did slip away a bit to 143.27.

  3. Hi Shaun

    Great article as always.

    Looks like house price crash is baked in now. The stamp duty change will have very little impact. I’m looking to remortgage at the moment and on wednesday 5yr fix was 3.7%. So 4.5% soon? This will kill the housing market.

    Help to buy has not been renewed either. The fed have stated that they’re happy that house prices will fall, maybe our new gment is? If only for their rich donors from abroad to pick up london mansions at bargin prices due to sterling being hammered.

    • This economic chicanery will now require interest rates of 6-7% to fight the inflation just added, to what we already have in the pipeline.
      The game is obvious: high/hyper inflation, then bust.
      The high levels of inflation will require helicopter printy-printy to stave of food/fuel riots requiring ever-higher interest rates, killing the housing market, & leaving many as tenants in their (at present) mortgaged homes.
      The proof in science is predictability, & I have been predicting this for some time.
      Approx. 18 months to 2 years ago, I warned, at zirp, that the thing to do was to pay down your mortgage as much as you could, & not take on ANY debt upon which your home was secured.
      It’s not incompetence, as I’ve warned on a number of occasions, these policies are absolutely required so that we will own nothing, since our homes have been huge “assets”.
      Well I have always said to treat your home like a commodity, & now we’ll see what I meant.

  4. Shall we start the clock ticking for our acceptance of the euro to replace the pound at say a rate of euro/£ 1.20-1.30 by the time the shouting is over????, approx 50% loss for sterling since the introduction of the euro twenty years ago, that is some feat of fianancial destruction there, requiring real skill and planning, never understimate these people.Where are all the euro bears and those predicting the breakup of the EU now ? Rather quiet aren’ they? Andrew Evans Pritchard et al hello?

    It doesn’t matter about the timing, as the Tories have already lost the next general election so either it will be on their watch or labour, both parties are controlled by the same people.The same economic destruction will be pursued until the desired outcome is achieved so they care not which party is in power.

      • A good job we have one running the country with about as much financial acumen as a fence post then?

        The results today proves you wrong. The predictions on this site over the last few years are now coming true in horrific detail, government borrowing and spending to prevent asset bubbles from collapsing, BofE monetising their gilt sales to come,to prevent bond market from forcing them to do the right thing which is stop interfering and let rates go to where they should be, Kwarteng said today “markets will do what markets do” when questioned about the consequences of their disastrous policies, but they won’t let “markets do what they do” as the BofE keep buying gilts to artificially keep interst rates lower than they should be!

        Weimar collapse will ensue unless they stop this insanity.

  5. I never realised the UK was so important.
    Liz Truss’s budget has reduced the world stock markets spectacularly.
    The Dow Jones, Amsterdam, Paris and Madrid have had a greater loss today than the Footsie – only Germany ties with us.
    As Shaun writes the B of E is the cause of the drop in sterling, with it’s signal that a 0.5% rise is all it wants in response to the Feds 0.75 rise and other countries up to 1%.

    • The UK isn’t that important, what other markets suspect is that other governments will copy the suicidal policies of the UK government and just borrow and print their way out of this mess, but of course they don’t know that housing makes up such a massive part of our economy and our government of the day will literally destroy its currency to prevent it from going down, other markets think their respective central banks will keep raising rates to compensate for all this new borrowing, this hardly applies over here!!!

      • Kevin,
        Sorry I did not lay out my sarcasm thick enough.

        I was just implying that nearly everybody was suggesting that it was Liz Truss had caused the fall in the stock market, where as all the stock markets fell in the West and apart from Germany they all fell more.

        I think that the fall in sterling was caused far more by the B of E. It’s decision to only raise IR by 0.5%, when the US had raised by 0.75% and the decision to unwind QE at this time did signal to the market that they would not even try to defend the £.

  6. That’s it from me now, I know Shaun doesn’t like politics so I won’t keep blurring the line here, but as I have said before, sometimes the overlap between politics and finance cannot be avoided, so I’ll take a long breather, my predictions of the incompetent clowns and traitors running this country into the ground and eventually the EU have been almost proven, so I’ll sign out with the future of the pound mirrored by the final scenes from Trading Places and the chaos that is going to ensue in the forex market as sterling goes to almost zero- a classic, just watch it and wonder how we could ever let our country be run by such people.

    You can compare the screaming of the Duke brothers to the utterances of the arrogant preening MP’s in the House of Commons that will ensue when they realise its all over and they can no longer print their way out of problems, inflate house prices and buy votes with the worthless “money” – Turn those machines back on!

  7. This economic chicanery will now require interest rates of 6-7% to fight the inflation just added, to what we already have in the pipeline.
    The game is obvious: high/hyper inflation, then bust.
    The high levels of inflation will require helicopter printy-printy to stave of food/fuel riots requiring ever-higher interest rates, killing the housing market, & leaving many as tenants in their (at present) mortgaged homes.
    The proof in science is predictability, & I have been predicting this for some time.
    Approx. 18 months to 2 years ago, I warned, at zirp, that the thing to do was to pay down your mortgage as much as you could, & not take on ANY debt upon which your home was secured.
    It’s not incompetence, as I’ve warned on a number of occasions, these policies are absolutely required so that we will own nothing, since our homes have been huge “assets”.
    Well I have always said to treat your home like a commodity, & now we’ll see what I meant.

  8. Further information on how the planet’s declining magnetic field is causing further ozone depletion, causing climate change:

    We’ve seen & discussed all the shortcomings with “unreliables” but the real problem is, that it is now beyond doubt that even if humanity is contributing to global warming, it is far from the sole contributor; that is undeniable.
    So we hit all our climate targets, & the World temp. keeps rising, sailing past 1.5C, what then?
    Wouldn’t we be far better spending on ADAPTING to climate change, rather than trying to stop it?
    Wasn’t it obvious that has ALWAYS have been the case, as we could have targeted spending as required, rather than having to front-load it?

    Do you see a pattern emerging?
    Elites making decisions which are obviously wrong & extremely costly (for ordinary folk).

    Climate Change spending.
    Covid lockdowns.
    Russian sanctions.

    I would suggest that yesterday’s “mini-budget” was another act of deliberate self harm for our economy too.

    If there IS a pattern, (& I would argue there is) then the problem cannot be incompetence; it’s self-harm by design.

    “Throwing as much money as they can at deliberately wrong choices.”

    It’s happening time & again.

  9. ‘according to Edwards, “the new Conservative PM Liz Truss and Chancellor Kwasi Kwarteng have very publicly renounced the Davos-centric, ideological consensus that has dominated the G7 economics mainstream for so (too?) long. Such is the wish to shed this economic orthodoxy, the most senior civil servant at the UK Treasury was fired as soon as Kwasi Kwarteng stepped through the doors.”
    Well, we are now at the other end of that spectrum, and according to the SocGen bear, the UK Government extremes of fiscal largesse will undoubtedly be countered by even more aggressive monetary tightening and QT, because of runaway inflation, rather than the monetary facilitation we saw in the pandemic. . . .
    the US is entering what he termed a “beta drought” where asset-class returns are negative or negligible for an extended period. “Prior droughts have been due to rising inflation and/or high market valuation. The US is now at risk from both.” . . .
    Not surprisingly, the rather (always) bearish Edwards thinks that Minack is right as the world is “likely set for a decade or more of poor financial returns exacerbated by the current ongoing economic ideological shift, which effectively means that interest rates and inflation will rise on a secular basis – i.e. The Great Melt.” ‘
    https://www.zerohedge.com/markets/albert-edwards-ice-age-over-replaced-great-melt-and-crushing-beta-drought

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