UK bond yields surge, pound plunges as bond vigilantes rise from their graves and tackle government fiscal recklessness

Bank of England: will not hesitate to increase the rates “as much as necessary”. The bond market fears much higher inflation and interest rates, for much longer.

By Wolf Richter for WOLF STREET.

Central banks, with their QE and interest rate crackdowns, were thought to have killed off any remaining bond vigilantes who hunted down governments that tampered with reckless fiscal policies and high inflation rates. Under these conditions, bond vigilantes – big institutional investors tired of being beaten down by government policies – refused to buy low-yielding bonds, thereby driving up interest rates and imposing high borrowing costs by as a punishment. But perhaps those feared but long-buried bond vigilantes are now rising from their unmarked graves as central banks have turned away from bond market support, turned to QT and started raising policy rates.

In the UK bond market, bond vigilantes came to life after the new government announced a massive package of tax cuts for the rich (removing the top tax rate and reversing a tax hike on corporations, in the classic form of trickle-down economics) accompanied by soaring spending due to very costly energy subsidies for businesses and households. While inflation is already raging around 10%.

The yield on British 10-year government bonds (gilts) jumped 44 basis points to 4.28% so far, bringing the peak since Tuesday last week to 113 basis points, as prices for bonds plunged:

The one-year yield on UK gilts climbed a monstrous 65 basis points today to 4.16% right now, bringing the peak that started on Tuesday to 121 basis points. These are huge gigantic movements of several days:

The pound crashed to a record low of $1.035 early this morning after Friday’s plunge, before rebounding to $1.07 for now, which is still down 23% from mid -2021. In 2007, the pound was still trading above $2, before the financial crisis caused it to fall to $1.50.

The initial issue was new Prime Minister Liz Truss’ “Growth Plan”, the details of which were announced late last week. The situation was then escalated with exemplary efficiency by Finance Minister Kwasi Kwarteng on Sunday when he talked to the BBC on this subject.

When asked about the fall of the pound and the surge in yields last week, he told the world – practically defying bond vigilantes to rise from their graves – that he was not focused on the movements of the market.

“As Chancellor of the Exchequer, I don’t comment on market movements,” he said. “What I am focused on is developing the economy and ensuring that Britain is an attractive place to invest.”

More tax cuts could be coming, he suggested, which didn’t help either. Asked in the interview that the new policies of tax cuts and increased spending would make already searing inflation even worse, he said it was the Bank of England’s responsibility to deal with to inflation, in accordance with the doctrine that Truss had set out. weeks earlier that inflationary government policies amid the worst inflation in decades were acceptable because it was not the government’s job to deal with inflation, but the central bank’s job.

“They are responsible for dealing with inflation,” he said. “They don’t work in isolation, and that’s why I said I would see the governor twice a week. And we share ideas, but of course he’s completely independent.

The Bank of England addressed this situation in a statement today, emphasizing that it would “not hesitate” to raise rates “as much as necessary to bring inflation back towards the 2% target”:

“The role of monetary policy is to ensure that demand does not outstrip supply in a way that leads to more inflation over the medium term. As MPC [the BoE’s Monetary Policy Committee] clarified, he will make a full assessment at his next scheduled meeting of the impact on demand and inflation of the government announcements, and the fall of the pound sterling, and will act accordingly. The MPC will not hesitate to modify interest rates as much as necessary to sustainably bring inflation back towards the 2% target in the medium term, in accordance with its mission.

Last week before the announcement of the government’s economic plan, the BoE raised its key rate by 50 basis points to 2.25%. The next rate hike is scheduled for November 3. It also confirmed QT, as expected in August: it would reduce its securities holdings by almost 10% over the next 12 months.

The BoE now has a much tougher challenge, as the government is throwing more fuel at inflation, and it may have to respond with more and bigger rate hikes, and more QTs, to try to slow that inflation down. .

And the bond market appears to be reacting to the simultaneous threats of much higher inflation than previously feared, fueled by these policies, and a much more vigorous inflation crackdown from the BoE with rates much higher interest rates for much longer than previously feared.

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