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The Bank of England is under increasing pressure to act as U.K. markets plunge into wild swings. The problem for Governor Andrew Bailey is that his options are limited and risky.
Conservative lawmakers, former Bank of England officials and City of London analysts have all called for emergency intervention to calm market jitters, but the central bank has so far been silent. The agency has not yet decided whether to issue a statement, although it is closely monitoring the market, according to people familiar with the matter.
“There are no good options for banks,” Evercore’s Krishna Guha wrote in a note on Monday. “We think the bank is more inclined to not take inter-meeting action, which could be counterproductive and counterproductive, and will first see if the government takes action or if the market finds a near-term floor.”
Here are potential avenues the Bank of England could use to address the rout following the new government’s broad tax cut package. The pound fell to a record low and bonds tumbled as traders increased bets on a rate hike by the Bank of England.
BOE rest assured
The most immediate short-term option is a statement by Bailey or the Bank of England to reassure markets and countries, similar to the statement made by former governor Mark Carney the morning after the 2016 Brexit referendum.
Sky News reports that could come as soon as Monday. Such a statement may be made through a television address or a written statement. Former Bank of England policymaker Adam Posen suggested that the governor should “open in the middle of the week” saying that if the pound falls, interest rates will rise.
If Bailey doesn’t speak, the job could go to one of the Bank of England policymakers who speaks this week. The most likely candidate is chief economist Huw Pill, who spoke on Tuesday. The question is whether words alone will work while markets remain volatile.
emergency rate hike
This could lead to an emergency rate hike. Calls for such a move began over the weekend, and the pace has since picked up. The Bank of England has raised interest rates to 2.25% this year to rein in inflation, most recently a day before earnings on Friday, but it faces accusations that it didn’t act fast enough.
Money markets now expect the Bank of England to raise rates by 200 basis points before its next meeting in November, more than three times the rate of its last hike. A bet of this size could mean hedging immediately.
The risk of emergency action is that it increases panic in the market, especially if it fails to stem losses. The Bank of England may also prefer to avoid such a move to avoid explicit criticism of government policy, said Dan Hanson of Bloomberg Economics.
“The big problem with an emergency rate hike right now is that it has to hit 200 basis points for it to work because the market has already priced in a substantial 100 basis point odds,” said Rishi Mishra, an analyst at Futures First.
The Bank of England’s response could be complicated by criticism the central bank has received from the incumbent this summer. Prime Minister Liz Truss had suggested during her leadership campaign that she would review the bank’s mandate, although Chancellor Kwasi Kwarteng has since said the government is committed to the Bank of England’s policy independence.
Pause QT
One possible reaction to the move in bond markets is for the Bank of England to delay planned sales of gilt bonds it bought under quantitative easing. The process will begin next week.
However, this could be seen as running counter to attempts to control inflation, and also against previous guidance.
The Bank of England has said that “the revised plan to reduce the stockpiles of gilts purchased will be held to a very high standard”. It was also pointed out earlier that these conditions refer to the functioning of the market. Trading in Phnom Penh on Monday was orderly despite heavy losses across the curve.
“The FPC will also play a role, through its assessment of financial stability, in judging whether this criterion is met,” officials said last week.
direct market intervention
Another option for the UK is to intervene directly to prop up the pound. However, the UK’s foreign exchange reserves are only a fraction of the much larger foreign reserves that may be needed, making the job even more complicated.
According to the International Monetary Fund, Britain had $108 billion in foreign exchange reserves at the end of August. Japan, which intervened last week to support its currency, has $1.17 trillion.
“Currency intervention will only be a solution for a few minutes,” Jens Nordvig, founder of New York-based research firm Exante Data, wrote on Twitter Saturday.
wait until november
The final option is to let the market reaction play out and save any policy reaction until November. This will give Kwarteng and Truss time to launch their own attempts to reassure investors of their plans.
Gerard Lyons, an outside adviser to Truss, said on Monday that while the Bank of England needs to act on interest rates, Kwarteng must do more to convince markets of his vision for the economy.
“He needs to reiterate that the tax cuts are part of the story, not the whole story,” the economist said in an interview with Bloomberg Radio on Monday.
“The market remains unconvinced that his fiscal easing is necessary, non-inflationary and affordable,” he added. It is clear from the market reaction that these concerns have not been adequately addressed. So, in subsequent comments, he may need to address these issues. “
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