IMF urges UK government to align policy with Bank of England – business live – The Guardian

The IMF has stepped up its criticism of Kwarteng’s mini-budget, saying it contributed to disorderly markets.

Tobias Adrian, the Fund’s Financial Counsellor, says the fiscal statement last month had led to perceptions that the Bank of England would need to raise rates higher to fight inflation, and that a different fiscal policy would take pressure off the Bank.

Adrian has told a press conference at the IMF’s Annual Conference in Washington DC that some of the rise in interest rates has been “disorderly”, while the “rapid” increase in gilt yields that forced the Bank to act.

Adrain said:

“A change in fiscal policy would change the trajectory of interest rates going forward.

The change in fiscal policy changed the expectations of monetary policy and meant the Bank of England would have to raise interest rates that much more to bring inflation back to its mandated target.”

🚨 NEW 🚨
IMF just asked whether only way to solve UK market problem is reverse mini budget tax plans…

IMF’s Tobias Adrian: “23rd Sep announcements triggered rising interest rates…some disorderly…

Yes a shift in fiscal policy would certainly change the trajectory in yields”

— Faisal Islam (@faisalislam) October 11, 2022

Asset purchases can also change yields in the market place but the BoE has an inflation price stability objective and that is going to stand in the way of having permanently lower interest rates”: IMF’s Adrian pic.twitter.com/2eBYJFRXu8

— Faisal Islam (@faisalislam) October 11, 2022

Adrian’s comments follow the IMF’s warning that Kwasi Kwarteng’s mini-budget would make it harder to fight inflation, while also lifting growth in the near-term:

The Bank of England has bought £1.363bn of conventional long-dated UK government bonds, in its latest daily operation to calm markets.

That’s on top of the £1.9bn of inflation-linked gilts it bought from investors (see earlier post) and means the central bank has stepped up the pace of its efforts to keep markets functioning.

🏦🇬🇧 BANK OF ENGLAND ACCEPTS 1.363 BLN STG IN DAILY LONG-DATED CONVENTIONAL GILT PURCHASE OPERATION

— Cable FX Macro (@cablefxmacro) October 11, 2022

Confirmation that the Bank of England’s latest intervention hasn’t calmed markets much:

Bank of England buys £1.95 billion of index-linked gilts in its first purchase of this type of bond. Rejects £467 million.

Yields for a lot of long-dated linkers now up a bit even on Monday’s close. Ouch. pic.twitter.com/OFQeStGyUy

— Andy Bruce (@BruceReuters) October 11, 2022

Back in parliament, Kwasi Kwarteng has said the government is committed to work with regulators to understand what has happened to the market for long-dated British government bonds in recent weeks.

Kwarteng told MPs:

“We will be absolutely committed to getting to the bottom of what’s happened in the …long-dated gilt market where it’s been over-levered over the last few weeks.”

That ‘over-leverage’ was driven by pension funds who had used LDI strategies to (they thought) protect themselves from adverse moves in interest rates. They faced energency collateral calls on those contracts when bond prices fell, triggering a sell-off that risked a ‘doom loop’.

But the trigger was the shock of Kwargent’s £45bn of unexpected tax cuts, without a credible plan to pay for them, during the worst year for bonds in decades, and when rising inflation was already pushing up interest rates.

Kwasi Kwarteng has destroyed his ‘fiscal credibility’, while the Bank of England’s monetary credibility is also at risk as it tries to maintain order in the bond market.

That’s the damning verdict of Charles Hepworth, investment director at GAM Investments, who warns that the markets still don’t believe the mini-budget is sustainable.

Hepworth says:

“Having been forced to step into the gilts market last month, The Bank of England has had to again foray into the index-linked end of the market as prices in these bonds come under ever increasing pressure. Having destroyed all fiscal credibility, Chancellor Kwarteng’s budget is still viewed by markets as unsustainable.

Even with his fiscal plan and the OBR’s economic forecast announcement being hastily brought forward early to October 31st, faith in his competence couldn’t get any lower.

“While the Bank of England had to state today that threats of ‘fire sales’ in the gilt market pose a risk to UK financial stability, this acknowledgement cannot be what the government wants to hear. Markets similarly are behaving in a fait accompli fashion, suggesting the BoE has limited tools to avert these ‘fire sales’.

The UK’s 30-year bond is down 23% over the last month, and it is now close to where it fell to just before the Bank was forced to intervene, suggesting monetary credibility is close to being lost. This needs to be sorted as soon as possible or wider cracks will start to build, but credibility is very difficult to restore once lost.”

Waiting to see what happens to #GBPUSD when the 30 Year UK Gilt hits 5.0% .. #Band_Aid_not_working #interestrates pic.twitter.com/ocprK74lH9

— Intraday Crude Oil Trader (@TheNextMoveIs) October 11, 2022

The Bank of England has bought almost £2bn of inflation-linked bonds today, hours after adding them to its emergency purchase operation.

The BoE accepted offers for £1.947bn of index-linked gilts, and rejected £466m of other offers [under the auction, it can choose which offers to accept to maintain orderly markets].

That’s a step-up in its bond buying. Until this week, the BoE had only bought £5bn of bonds in total, despite having a daily limit of £5bn (raised to £10bn yesterday).

Prices of long-dated linker bonds mostly turned negative on the day after the results of the operation were announced, Reuters reports.

Over in parliament, Chancellor Kwasi Kwarteng has been facing MPs for the first time since his mini-budget caused mayhem in the markets, at Treasury questions.

Mel Stride, the Conservative chair of the Commons Treasury committee, suggested to Kwarteng that he should only announce measures in his fiscal plan due on 31 October if he is confident that he will be able to get them through the house.

Kwarteng replied that:

“We will and should canvass opinion widely ahead of the publication of the plan.”

The chancellor also said Stride is doing a “brilliant job” and has offered “wise counsel”.

However, our Politics Live blogger Andrew Sparrow reports that Kwarteng does not sound 100% sincere at this point – as Stride has been one of his strongest Tory critics.

There’s full coverage here:

Meanwhile in the UK retail world, Frasers is stretching its interest in online fashion into new territories with a the purchase of a 4.5% stake in N Brown.

N Brown owns JD Williams, which is aimed at older shoppers, Simply Be, which offers larger sizes, and Jacamo for taller men.

N Brown’s shares have tumbled in the past year but ticked up on Tuesday on news of Frasers’ interest. Frasers, which owns Sports Direct, House of Fraser and Flannels, has recently bought ailing online brands including Missguided, I Saw it First and Studio Retail.

IMF chief economist Pierre-Olivier Gourinchas has told a press conference in Washington that the UK government should align its tax and spending policy with the Bank of England’s inflation-fighting goals.

Gourinchas points out that we have seen ‘a lot of turbulence’ in the market for UK debt, which shows the importance of keeping fiscal and monetary policy in line.

.@pogourinchas on the UK “We’ve seen a lot of turbulence in the gilt market of late. We’ve seen market disfunction. There’s been a need for the Bank of England to come in.” #IMF #WEO

— ThomasHCole (@ThomasHCole) October 11, 2022

As he puts it:

“Central banks are trying to tighten monetary policy, and if you have at the same time fiscal authorities that try to stimulate aggregate demand, it’s like having a car with two people in the front … each trying to steer the car in a different direction. That’s not going to work very well.”

Gourinchas says that fiscal and monetary policy should pull in same direction and suggests (not quite saying this explicitly) that UK has been a bit like a car with two drivers pulling in opposite directions on the steering wheel.

— Andrew Walker (@andrewwalker167) October 11, 2022

Gourinchas welcomes Monday’s decision to

The IMF has criticised energy price caps introduced by countries including the UK, saying such interventions ‘rarely work’.

The Fund warns that the energy crisis, especially in Europe, is not a transitory shock.

Instead the geopolitical realignment of energy supplies in the wake of the war is broad and permanent, meaning the situation will be worse in a year’s time.

IMF chief economist Pierre-Olivier Gourinchas say governments should offer targeted help, while letting rising prices cut demand.

Winter 2022 will be challenging, but winter 2023 will likely be worse. Price signals will be essential to curb energy demand and stimulate supply.

Price controls, untargeted subsidies, or export bans are fiscally costly and lead to excess demand, undersupply, misallocation, and rationing. They rarely work. Fiscal policy should instead aim to protect the most vulnerable through targeted and temporary transfers.

IMF’s latest set of policy recommendations for the world economy are out today:
💥Central bank’s should keep raising rates despite risks
💥Governments need to rebuild fiscal space
💥 FX intervention and capital controls are fine if you need them
💥Energy price 🧢 are v v bad

— Mehreen Khan (@MehreenKhn) October 11, 2022

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.

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.

Global inflation is proving to be broader and more persistent than we anticipated. We expect it to peak at 9.5% this year before slowing to 4.1% by 2024. https://t.co/SnntPSlwet pic.twitter.com/V0DvhaqIFj

— IMF (@IMFNews) October 11, 2022

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.

IMF Chief Economist @pogourinchas: The world’s three largest economies—US, China, and the euro area—will continue to stall. The worst is yet to come and for many people, 2023 will feel like a recession. https://t.co/SnntPSlwet #WEO pic.twitter.com/mhNpxedXEC

— IMF (@IMFNews) October 11, 2022

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.

IMF: CUT 2023 GLOBAL GROWTH FORECAST TO 2.7% FROM 2.9% IN JULY ESTIMATE. 2023 GLOBAL GROWTH COULD FALL TO 1% UNDER ‘DOWNSIDE SCENARIO’ OF 30% OIL PRICE JUMP, CHINESE PROPERTY DISRUPTIONS, OVERHEATED LABOR MARKETS AND SEVERE FINANCIAL TIGHTENING.

— CN Wire (@Sino_Market) October 11, 2022

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:

Next U turn. This is simply not possible along with £60 odd billion of spending cuts. And it wasn’t possible before either. Truss’s cunning plan, such as it is, is dead on arrival unless the govt bullies OBR into gdp forecast fiction, which the OBR won’t fall for. We hope pic.twitter.com/IqlROXM4Yz

— George Magnus (@georgemagnus1) October 11, 2022

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.

BoE drawn into risky game of financial whac-a-mole https://t.co/0o8Fdu4f3B @Unmack1 pic.twitter.com/Pz4RdyoRKh

— ReutersBreakingviews (@Breakingviews) October 11, 2022

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.

About The Author

James Kugmo