This issue: What will the Bank of England do next?
- Forecast: How likely is it that the Bank of England announces a rate increase of 1 percentage point or more in its Nov. 3 meeting?
- Deadline: Forecasts must be made by 9am Wednesday 10/5.
This is a wonky one... Enjoy.
Pity the Bank of England. It is fighting several fires—inflation, an energy crunch, a possible recession, and now a mini-financial crisis—while the UK government is in the other room playing with matches.
Friday before last, the Truss government outlined a “mini-budget” combining energy price caps with tax cuts, mostly for the rich. Markets ran the other way, causing the value of the pound to plummet and prompting a mini-financial crisis.
This is not the first time a central bank and a central government appeared to be at cross purposes. In 2014, in his final speech as outgoing Fed chair, Ben Bernanke called out the US Congress for failing to do its part to stimulate the economy in the wake of the financial crisis:
Translated from ultra-conservative Fed speak, it was a bit like that Mark Wahlberg line from The Departed:
Central banks, for all their faults, have mostly spent the last 15 years trying to do their jobs. Legislators have frequently made those jobs harder, including by embracing austerity in the 2010s. But central banks can only do so much—to boost an economy, or even to fight inflation. At some point investors start to ask: What about the other guys?
Now the Bank of England has to weigh which challenge is most urgent. It reversed course this week and announced it would buy bonds to prevent a crisis involving private pension funds from spiraling out of control. Next it has to decide whether to hike rates faster than planned (to undo the efforts of the government it nominally works for) or to go slowly (for fear of exacerbating the financial chaos that the government helped to create).
- The UK has been experiencing high inflation—consumer prices were roughly 10% higher in August than the prior year. And while it doesn’t import much gas from Russia, it’s facing higher energy prices as a result of the invasion of Ukraine. The UK is also plagued by sluggish economic growth and low labor productivity relative to its peers.
- Friday before last, the Truss government introduced a “mini-budget” containing energy price caps and tax cuts. The energy price caps are estimated to cost the government £100bn over two years (to reimburse energy producers) while the tax cuts will cost about £30 billion a year in lost revenue. No government forecast of the plan’s effects was provided.
- Markets did not care for it. By Wednesday, the pound had fallen to a 37-year low (before recovering at the end of the week). And the price of UK government bonds dropped precipitously. Analysts mostly did not buy that the tax cuts would spur growth, and focused instead on the additional public debt and the potential for more inflation. The IMF even publicly criticized the plan.
- Then private pension funds found themselves in a mini-financial crisis. The funds had used derivatives to hedge themselves and as long-term bond prices fell they needed to put up more collateral—which meant selling more long-term bonds, driving prices even lower. Things got so “close to imploding,” per the FT, that the Bank of England stepped in to buy government bonds to calm the market.
- The central bank declined to make an emergency interest rate hike, but issued a statement about doing “as much as needed” to tame inflation. Its next meeting is November 3. One thing to know about UK interest rates: Most homeowners have floating rather than fixed-rate mortgages.
Against the mini-budget
A partial defense
On the financial reaction
What happens next
Bank of England Official Rates
In August and September, the Bank of England raised rates 0.5% each meeting.
How likely is it that the Bank of England announces a rate increase of 1 percentage point or more in its Nov. 3 meeting?
Deadline: Make a forecast by 9am ET Wednesday, 10/5
What do you think?
This question will resolve based on the Bank of England's meeting summary published Nov. 3.