The British finance minister was very firm in his answer to the “Sky News” reporter who pestered him with the question of what would happen in the markets after Friday, the date when the “Bank of England” promised to stop the intervention amounting to tens of billions of pounds in the trading of government bonds. “It’s a matter for the governor of the central bank,” he said again.
Formally, Minister Quazi Kwarteng is right – maintaining the stability of the financial system is one of the overarching goals of the Bank of England. The governor and his advisers are the ones who will decide on the question that is hovering over the markets – whether they will continue to intervene in the government bond market in the coming weeks as well, against the background of fear of bankruptcy of pension funds and a jump in the costs of British loans.
But in practice, Kwartang and the new British government, headed by Liz Truss, are the ones who started the fire in the government bonds, which the central bank now has to deal with.
The “mini-budget” that the government presented to Parliament in the last week of September was a blatant fiscal intervention and completely opposite to the direction the Bank of England had outlined in the last six months. It included promises of £45 billion in tax cuts, another £150 billion in energy subsidies and a host of controversial measures. All this this year, and without any source of funding for this being shown.
What Quartange and Truss failed to understand was that the rules had changed; The era of cheap money has come to an end, the Bank of England’s frequent interest rate hikes are drying up the financial market (as well as at the international level) and the economic outlook is becoming bleaker by the day.
This was simply not the time to scatter the well-worn promises about “growth and more growth”, about economic prosperity that would trickle down. And certainly not guaranteeing to finance it all by increasing the British national debt, which has already jumped from 79% to 104% of annual GDP in three years. It was a bad economic plan, like others before it, but what the politicians leading Britain failed to understand was that the price on it will be charged immediately, in the financial markets.
Does anyone know what risks the financial market entails?
At the heart of the matter is the fact that no one really knows what is happening in the markets. Was anyone in the British government aware of the indirect and huge exposure of pension funds, worth close to a trillion pounds, to the yield on a British 30-year bond, through insurance transactions and in accordance with the rules that require them to sell to cover losses (LDI)? It seems not. The financial rules are being rewritten now, after more than a decade of quantitative easing.
The water is receding now – to paraphrase Warren Buffett’s well-known statement – gradually indeed, but no one knows what the state of the swimwear is among the financial bodies, from Credit Suisse to the Prudential Fund. Does anyone know what additional requirements for collateral (Margin Call) the financial market as a whole is currently harboring, and which “low risk” products will suddenly explode when the banks tighten monetary policy?
Will the budget at the end of October calm the markets?
In her maiden speech to the Conservative Party, Liz Truss promised to “Deliver” everything to the British people: prosperity, security and peace. Since then she has already had to go back on most of the promises.
Meanwhile, the British economy shrank by 0.3% last month. Mass strikes, demanding a permanent wage increase (which may further fuel inflation, which is close to 10%), are on the way. Industrial production fell by 1.6%, and the country is still paying the bill for the billions that Brexit has cost it so far. The pound, also due to the turmoil in the British bond market, has already hit an all-time low against the dollar this month, and has approached it again in recent days.
The government hopes that presenting a budget on October 31 – but this time more balanced and with clear funding sources – will help to calm the markets and lower the excess yield on government bonds. It can only hope that it will work, since the fight over the bonds has already become a subject of speculation Financially, and perhaps many billions will be required from the Bank of England to prove its commitment to the decrease in yield on them. The question is what will happen after the presentation of the budget, while more “victims” of the tightening financial conditions will surface, and at what cost.