Bank Of England Bond-Buying Reverses Strategy To Tame Inflation

  • Market Overview
  • Editors Pick
  • UK government to keep top tax rate but credibility badly damaged
  • Eurozone inflation at 10% galvanizes ECB policymakers
  • US investors see light at the end of the tunnel

The British government has abandoned its plan to eliminate the top tax bracket of 45% for earnings over £150,000. The pound sterling and government bonds have regained some ground but the new cabinet of Prime Minister Liz Truss has lost a lot of credibility.

Bank of England Governor Andrew Bailey had to step in with an emergency facility to buy £65 billion of long-dated government bonds to keep pensions funds that were using derivatives to hedge their investments from blowing up with margin calls.

This was the opposite of what Bailey and the central bank wanted to do since they have been trying to tame inflation with higher interest rates and tighter liquidity from selling bond holdings. Regulators are worried what will happen when the Bank of England emergency facility ends in mid-October.

Predictably, the British press pilloried the new chancellor of the exchequer, as the finance minister is known, blaming him for aiding rich people when ordinary people are being battered by price increases.

Suddenly, Kwasi Kwarteng, the son of Ghanaian immigrants who was raised in the best British traditions, was an acknowledged paragon of brilliance but also out of touch and tone deaf with the characteristic arrogance of the elite.

There is no guarantee, once the dust settles that Kwarteng or even Truss will survive politically, and certainly, their effectiveness has been badly damaged. That’s what can happen when you install a government espousing radical change without an election.

Bailey, whose own feeble efforts to nip inflation in the bud have been subject to severe criticism, is looking like a hero, at least for now. But the central bank governor, whose recent stint as head of the UK’s Financial Conduct Authority remains controversial, may come due soon for his own reckoning.

Britain, in short, is a mess. The opposition Labour Party has shot up in popularity, finally recovering from the disastrous tenure of old-school socialist Jeremy Corbyn as a leader (US Democrats, pay attention).

Europe as a whole is in a bad way. The German government threw caution to the wind and put a €200 billion plan to aid consumers hit by skyrocketing energy prices, and promptly drew criticism from smaller and less prosperous EU countries—which means all other 26 member states—as well as from the European Commission.

Germany is the hardest hit by Russia’s energy extortion, but then it was Germany that for years ignored numerous warnings about putting the country at the mercy of Vladimir Putin.

The European Central Bank, meanwhile, has gotten religion and is now planning on raising interest rates rapidly. Probably too late. Eurozone inflation registered at 10% last week for September, outpacing that in the US and galvanizing even the ECB policymakers into action. 

The central bank is now expected to boost its policy rates by 75 basis points (bp) at its meeting later this month to put the inflation genie back in the bottle. This would never have happened if the German central bank, the Bundesbank, was running things, but the essence of European unity is compromise—and timidity.

The US is in better shape. The Federal Reserve has been assiduously hiking overnight rates and is likely to continue doing so at a 75 bp clip. The possibility of a recession has chased investors out of stocks and they are seeking refuge in Treasury bills, which now sport a decent rate of 3.2% over three months. Not only that, investors are sure of getting their money back.

Yield on the two-year Treasury bonds has topped 4%, hitting over 4.27% on Friday before declining on Monday to settle at above 4.11%. But investors decided on Monday that stocks had been oversold in a brutal third quarter, so that broad-based indexes gained about 2.5%. One glimmer of hope, strategists say, is that the Fed may ease up on rate hikes next year if inflation comes down. 

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