In what must be one of the most embarrassing U-turns in British political history, the package of tax cuts launched by Liz Truss and Kwasi Kwarteng, currently UK prime minister and chancellor respectively, has been slashed from an unthinkable, kamikaze £45bn to a solemn, dignified £43bn.
Combined with the Bank of England’s action to stabilise gilt markets last week in order to save the world/the UK financial system/pension funds/Legal and General, everything’s hunky-dory again in old Albion.
As proof of this, the pound has climbed about a cent against the dollar, and gilts yields are down.
Hold up. The Bank’s emergency action last week seemed to act as something of a circuit-breaker for anguished markets, but there’s still a lot of blood in the water.
Over at the FT, Robert Shrimsley has counted the political damage:
There will be other visible signs of contrition, more consultation and more visible work with the OBR. But privately many MPs doubt Truss can change enough to prevent other mistakes, not least because she still sees the issue as a political mis-step rather than an error of economic policy. This matters because markets and MPs will want to see evidence that she understands that the mistakes were caused by more than just faulty communication.
But as much as Number 10 might want to treat this as a Jeremy Clarkson-esque “Oh no! Anyway . . . ” moment, it’s really not clear that markets are anywhere near being out of the woods.
MPs are already preparing a postmortem on the LDI turmoil last week, but the death throes may not yet have begun.
Gilt markets — which were at the centre of last week’s disaster — have calmed, but unlike sterling they haven’t settled. Yields on 10-years are still only about half a percentage point lower than they were before Bailey and co. rode to the rescue, and the 30-year, where the BoE is still targeting purchases, is still roughly aligned with its “mini”-Budget-day levels.
For now, the bond vigilantes may be held at bay, but there’s a clear cliff-edge ahead: the BoE has said it will wind up its operations on October 14th, ie next Friday.
Here’s ING’s rates team today:
Since it is very limited in time, until 14 October, we think volatility could resume, especially if hopes of a more conservative fiscal stance are disappointed. 10Y gilts below 4% in yields would be a selling opportunity in our view.
Though there’s a chance the government’s (welcome) about-face will calm market fears that they are reckless libertarian zealots, the fundamental picture hasn’t changed very much.
We reported early last month that the upcoming surge in government borrowing would complicate the BoE’s long-awaited QT process. It’s fair to say Alphaville wasn’t anticipating quite such an extraordinary postponement (and it’s procedurally interesting to recall that delaying active gilt sales to October 31st was not even a Monetary Policy Committee decision).
Writing at the end of last week, Morgan Stanley analysts reckoned even that new, Hallowe’en start date now looks shaky:
While the BoE looks committed to active sales at some point, the risks are clearly skewed towards a further delay, especially in the case of further market volatility following the end of the temporary purchasing programme on October 14.
This creates another fine old mess for Andrew Bailey. Although they caused alarm in the eurozone, last week’s gilt market dynamics remained a distinctly British phenomenon. It is probably therefore a fair read (one Alan Beattie has explored in his Trade Secrets column today) that this is, indeed, the government’s fault.
With that in mind, the BoE may soon find it has pinned itself in a position where it is continuing to shield companies from the consequences of their own actions AND also providing cover for some spectacularly bad government spending decisions, all while being left unable to pursue what it had independently determined to be the best course of action.
It could be a long month over at Threadneedle Street.