Many pension funds want BoE to extend its support
Many pension funds want the Bank of England to extend its support for the UK government bond market beyond its cut-off date of 14 October, the industry trade body says.
The Pensions and Lifetime Savings Association has welcomed today’s BoE’s decision to start buying inflation-linked bonds on top of other gilts, calling it a “positive additional intervention” in its attempt to keep the market operating in an orderly way.
But, the PLSA also warns that many funds are worried about what happens after Friday, when the Bank is due to end its daily bond purchases.
It says some funds want the support extended until Kwasi Kwarteng has revealed his medium-term fiscal plan at the end of the month.
Following this morning’s and yesterday’s statements by the Bank of England, we will further assess with our members whether they believe any additional actions are necessary to achieve orderly markets.
However, a key concern of pension funds since the Bank of England’s intervention has been that the period of purchasing should not be ended too soon, for example, many feel it should be extended to the next fiscal event on 31 October and possibly beyond, or if purchasing is ended, that additional measures should be put in place to manage market volatility.
With this in mind, we welcome that the Bank of England itself stated last week, that “it intends to unwind its gilt operation in a smooth and orderly fashion” and only “once risks to market functioning are judged by the Bank to have subsided”.
The PLSA also points out that the Bank’s early intervention was “generally effective” in helping bond prices recover (bringing down yields) meaning it only bought up £5bn of bonds so far, from a facility of £65bn.
“Recent days have, however, shown that market confidence remains low”, it adds.
The PLSA is also urging pension funds to take steps now to re-balance portfolios and protect their strategies in uncertain times.
Key events
Filters BETA
The IMF expects particularly weak growth in the eurozone next year, saying:
In the United States, the tightening of monetary and financial conditions will slow growth to 1 percent next year. In China, we have lowered next year’s growth forecast to 4.4 percent due to a weakening property sector and continued lockdowns.
The slowdown is most pronounced in the euro area, where the energy crisis caused by the war will continue to take a heavy toll, reducing growth to 0.5 percent in 2023.
Almost everywhere, rapidly rising prices, especially of food and energy, are causing serious hardship for households, particularly for the poor.
IMF criticises Kwarteng again over tax cuts and energy package
Larry Elliott
Kwasi Kwarteng has come under fresh fire from the International Monetary Fund after the Washington-based organisation said his tax cuts and energy support package had made the Bank of England’s battle against inflation more difficult.
The IMF used its prestigious world economic outlook (WEO) to criticise the scale of the stimulus provided by the chancellor and the blanket nature of the price cap on gas and electricity bills, our economics editor Larry Elliott reports from Washington DC.
It said the UK was on course for a sizeable slowdown in growth from 3.6% this year to 0.3% in 2023 but said its forecasts had been made before Kwarteng delivered his mini-budget on 23 September.
The IMF said:
“The fiscal package is expected to lift growth somewhat above the forecast in the near term, while complicating the fight against inflation.
Financial markets expect Threadneedle Street to raise interest rates – currently at 2.25% – by at least 0.75 percentage points at its next meeting in early November.
The WEO noted the hostile market reaction to Kwarteng’s September package, which forced the Bank of England to announce emergency measures to halt a run on pension funds.
It said:
“In the United Kingdom, the announcement in September of large debt-financed fiscal loosening, including tax cuts and measures to deal with the high energy prices, was associated with a rise in gilt yields and a sharp currency depreciation that was later reversed.”.
Here’s the full story:
The IMF also warns that inflation pressures are proving broader and more persistent than anticipated, despite the economic slowdown.
Global inflation is now expected to peak at 9.5% this year, and drop to 4.1% by 2024.
IMF chief economist Pierre-Olivier Gourinchas says central banks must stay firmly focused on taming inflation, despite the risks of creating a deeper recession:
Over-tightening risks pushing the global economy into an unnecessarily severe recession. Financial markets may also struggle with overly rapid tightening.
Yet, the costs of these policy mistakes are not symmetric. The hard-won credibility of central banks could be undermined if they misjudge yet again the stubborn persistence of inflation. This would prove much more detrimental to future macroeconomic stability.
IMF warns ‘worst is yet to come’ as it cuts 2023 growth forecasts
The International Monetary Fund has cut its global growth forecasts for next year, and warned that the worst is yet to come.
In its latest World Economic Outlook, just released, the IMF warned that conditions could worsen significantly year, as countries are hit by the disruption from the Ukraine war, high energy and food prices, inflation and sharply higher interest rates.
The IMF predicts that global GDP growth next year will slow to 2.7%, compared to a 2.9% forecast in July, and down from 3.2% expected this year.
One-third of the world economy will likely contract this year or next amid shrinking real incomes and rising prices, it fears.
IMF chief economist Pierre-Olivier Gourinchas said in a statement:
The three largest economies, the United States, China, and the euro area will continue to stall.
Overall, this year’s shocks will re-open economic wounds that were only partially healed post-pandemic.
In short, the worst is yet to come and, for many people, 2023 will feel like a recession.
The IMF put a 25% probability of global growth falling below 2% next year – a phenomenon that has occurred only five times since 1970 – and said there was a more than 10% chance of a global GDP contraction.
A “plausible combination of shocks” including a 30% spike in oil prices from current levels could darken the outlook considerably, the IMF said, pushing global growth down to 1.0% next year – a level associated with widely falling real incomes.
Investors fear more volalility in run-up to Halloween debt-cutting plan
Investors are warning that the markets will remain volatile ahead of Kwasi Kwarteng’s announcement of his medium-term debt reduction plan on 31 October.
Richard Carter, head of fixed interest research at Quilter Cheviot, says the Bank of England faces an ‘incredibly difficult balancing act’, after it said today it would start buying inflation-linked bonds, a day after doubling the maximum size of its daily purchases from £5bn to £10bn.
“This morning the Bank of England has once again felt the need to intervene in the fixed income market following yesterday’s announcement as it seeks to calm nerves and return stability to government bond markets. We are in somewhat unprecedented territory here and as a result yields continue to climb higher as investor fears are yet to be eased.
“The move by the BoE today to include index-linked gilts in their emergency quantitative easing programme is probably sensible given the massive rise in yields that occurred yesterday, however, it is going to be an incredibly difficult balancing act at a time when the Bank wants to be raising interest rates in order to bring inflation down.
It is stuck between a rock and the hard place in combatting inflation at the same time as fiscal policy causes shockwaves in markets. As a result, we expect gilt markets to remain volatile ahead of the Chancellor’s fiscal plan speech at the end of the month and potentially beyond as it remains to be seen how effective the government’s growth plan will be.”
Sandra Holdsworth, UK head of rates at Aegon Asset Management, told the FT that:
“Two interventions in 24 hours is pretty extraordinary,”
Holdsworth added that the BoE’s steps showed how the problem in the pension industry was “much bigger than anyone thought a week ago”.
Economist George Magnus doesn’t believe the government will be able to press on with its current economic plan, given the state of the markets and the economy:
James Athey, investment director at abrdn, warns that the Bank of England may have ‘trapped’ itself in its bond-buying programme.
“The Bank of England and government have inadvertently combined to put themselves, the UK economy and most dramatically UK financial markets in a perilous and uncertain position. While the medium term wisdom of providing significant fiscal support to the UK economy can be debated, doing so at a time of such heightened volatility in markets and with inflation still raging seems quite obviously ill-advised.
“The Bank has been far too intransigent in its response to the inflationary backdrop this year. In being so it laid some of the foundations for the illiquidity and volatility which characterise the UK government bond market today. Their decisions now are even more fraught as a lack of aggression will be perceived as weakness while an over-enthusiastic response could be seen as panic.
“Their recent attempts to deal with weakness and volatility in UK asset markets, ably assisted by the pernicious impact of excess and unwise leverage in the LDI sector, are but mere sticking plasters.
“As ever though the maxim will hold true – there is nothing so permanent as a temporary government program and the risk for the Bank is that they have already trapped themselves into a program of asset purchases at a time where their mandate dictates they should be withdrawing liquidity to tighten policy.
The announced deadline for these temporary gilt purchases is drawing near and neither weakness nor volatility have meaningfully subsided in the gilt market. The next few days are likely to be a rollercoaster whatever the technocrats in Threadneedle Street decide.”
A distressed bond market, and a wayward government, will make it harder for the Bank of England to end its support for long-dated bonds.
So writes Neil Unmack of Reuters Breakingviews, who explains that BoE governor Andrew Bailey is being drawn into a ‘risky game of financial whac-a-mole’ as it tries to calm panic in the markets.
Bailey has consistently had to expand support since late September. On Tuesday, he moved to buy index-linked bonds, and delayed long-planned sales of corporate debt from the bank’s old pandemic-era interventions.
There are plenty of signs that the bond market remains distressed. UK 10-year gilt yields, which have so far not been in the bank’s sights, surged around 30 basis points on Monday. The gap between the price at which banks will buy and sell gilts is above 5 basis points, up fivefold from a year ago, according to ING analysts.
Company borrowing costs are surging too: even low-risk investment grade UK corporate bond yields exceeded 7% on Monday, according to an ICE Bank of America index, which was more than 1.5 percentage points higher than before Truss’s so-called mini-budget.
So with Kwasi Kwarteng facing a £62bn black hole in the public finances due to his unfunded tax cuts, which could require ‘politically implausible’ spending cuts, investors may continue to steer clear of UK gilts if they can’t see a credible fiscal strategy.
Here’s the full piece.
The picture in the bond market remains troubling – despite the Bank of England beefing up its emergency support package twice in two days.
UK 30-year gilt yields now flat on the day, after Monday’s alarming surge.
The IFS have written a Twitter thread, showing how around £60bn of spending cuts would be needed to stabilise debt as a share of national income in 2026–27, due to weak growth, rising inflation, and the government’s unfunded tax cuts.
The IFS has been outlining how Kwasi Kwarteng’s tax-cutting mini-budget will drive up the national debt.
The IFS calculates that borrowing this year is likely to hit almost £200bn, its third-highest peak since the war, roughly double the £99bn forecast by the OBR in March.
Part of this surge is due to the government’s vast energy support package, but borrowing is still set to remain substantially elevated once those caps on the price of energy end.
The IFS says there is ‘huge uncertainty’ around the exact details, but its central forecast is for borrowing to still be around £100bn in 2026–27, around £70 billion higher than forecast in March.
It says:
Much of this increase is uncertain – it will in particular depend on the path of the economy, inflation and interest rates.
Less uncertain is £43bn of the increase in borrowing, which is explained by the direct impact of the permanent tax cuts announced by the new Chancellor, Kwasi Kwarteng.
Rising debt interest payments will also push up spending, with the government now having to pay higher yields to sell its debt.
But there’s also the ‘credibility cost’ of announcing unfunded tax cuts, alarming the markets, as Sky News’s Ed Conway reports:
Citigroup, which contributes economic forecasts for the Green Budget, predicts that real-terms GDP will rise by just 0.8% per year over the next five years, a very weak preformance.
Inflation is to peak at just under 12% over the coming months, and fall back only gradually, as the cost of living crisis grinds on.
Chief UK economist Benjamin Nabarro says there are few easy policy answers to the UK’s difficult economic outlook
Over the coming months, the terms-of-trade shock associated with the conflict in Ukraine will squeeze both firms and households. For the former, the regressive nature of the hit increases the macroeconomic risks.
The medium-term outlook for investment remains strikingly weak. Aggressive monetary tightening suggests any meaningful recovery is likely to be pushed into 2025.
In another blow to households, petrol and diesel prices at the pumps have started to rise again.
The AA reports that prices have turned higher, after more than three months of falls.
Petrol cost an average of 162.78p a litre yesterday, up from 162.32p/litre in the middle of last week.
Diesel on UK forecourts is also on the climb again, rising to 182.17p a litre from 180.28p/litre last Wednesday.
The increases follow a rise in wholesale fuel costs, as this chart shows:
The AA says the turnaround comes after oil producing countries in Opec+ cut output to boost the value of crude, adding close to $10 to the cost of a barrel, adding:
At the same time, refinery strikes in France took 60% of their capacity offline, squeezed market supply of the two fuels and pushed up wholesale costs:
A spokesperson for Liz Truss has said it’s up to the Bank of England whether it ends its bond-buying scheme on Friday as planned, Reuters reports.
Here’s the story:
The Bank of England’s additional measures to buy inflation-linked debt until the end of this week will support an orderly end to its temporary gilt purchase scheme, a spokesperson for British Prime Minister Liz Truss said on Tuesday.
“The additional measures today will support an orderly end to the Bank of England’s temporary purchase scheme. We see it as in line with its financial stability objective and we are in regular contact with the bank who will closely monitor the markets in the coming days,” the spokesperson told reporters.
Asked whether the temporary purchase scheme would end on 14 October as planned, the spokesperson said it was a matter for the independent central bank.
Mortgage rates keep climbing over 6%
Average two and five-year fixed mortgage rates have continued to rise to their highest levels in over a decade, as lenders reprice offers following the mini-budget.
The average two-year fixed mortgage on the market on Tuesday now had a rate of 6.43%, according to Moneyfacts.co.uk, the highest since August 2008 (just before the collapse of Lehman Brothers in the financial crisis).
The average five-year fixed-rate has risen too, to 6.29%, the highest level since November 2008.
These higher rates will price some new buyers out of the market, and push up the cost of remorgaging by several hundred pounds per month.
UK forced to borrow at highest rate since financial crisis
The UK has sold £900m of inflation-linked bonds, but had to agree to pay the highest interest rate since the financial crisis.
This morning’s auction of an index-linked gilt attracted almost three times as many offers, but the successful investors will receive a yield of 1.5% each year on top of the RPI inflation rate.
That’s the highest since October 2008, Reuters reports.
This chart shows how the price of a 50-year UK government bond has fallen sharply over the last year:
Reminder: The Bank of England warned this morning that the UK still risks a “self-reinforcing ‘fire sale’”, if pension funds are forced to sell bonds due to tumbling prices.
It explained:
The purpose of these operations is to enable LDI [pension] funds to address risks to their resilience from volatility in the long-dated gilt market. LDI funds have made substantial progress in doing so over the past week.
However, the beginning of this week has seen a further significant repricing of UK government debt, particularly index-linked gilts. Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to UK financial stability.
Many pension funds want BoE to extend its support
Many pension funds want the Bank of England to extend its support for the UK government bond market beyond its cut-off date of 14 October, the industry trade body says.
The Pensions and Lifetime Savings Association has welcomed today’s BoE’s decision to start buying inflation-linked bonds on top of other gilts, calling it a “positive additional intervention” in its attempt to keep the market operating in an orderly way.
But, the PLSA also warns that many funds are worried about what happens after Friday, when the Bank is due to end its daily bond purchases.
It says some funds want the support extended until Kwasi Kwarteng has revealed his medium-term fiscal plan at the end of the month.
Following this morning’s and yesterday’s statements by the Bank of England, we will further assess with our members whether they believe any additional actions are necessary to achieve orderly markets.
However, a key concern of pension funds since the Bank of England’s intervention has been that the period of purchasing should not be ended too soon, for example, many feel it should be extended to the next fiscal event on 31 October and possibly beyond, or if purchasing is ended, that additional measures should be put in place to manage market volatility.
With this in mind, we welcome that the Bank of England itself stated last week, that “it intends to unwind its gilt operation in a smooth and orderly fashion” and only “once risks to market functioning are judged by the Bank to have subsided”.
The PLSA also points out that the Bank’s early intervention was “generally effective” in helping bond prices recover (bringing down yields) meaning it only bought up £5bn of bonds so far, from a facility of £65bn.
“Recent days have, however, shown that market confidence remains low”, it adds.
The PLSA is also urging pension funds to take steps now to re-balance portfolios and protect their strategies in uncertain times.
Discover more from Today Headline
Subscribe to get the latest posts to your email.