“THE better part of valour is discretion,” Shakespeare wrote in Henry IV, Part One. Chancellor of the Exchequer Kwasi Kwarteng bowed to the inevitable on Monday and U-turned on his plans to lower the highest rate of income tax.
The Bank of England (BoE) should mirror his caution by shelving plans to sell its bond holdings for at least the rest of this year.
Kwarteng has the BoE to thank for calming markets sufficiently to give him the space to make adjustments to the tax giveaways announced Sept 23.
After the reversal on the most controversial element of the package, the sterling briefly strengthened versus the dollar but swiftly reversed its gains.
UK government bond yields took only fleeting notice and were higher on the day. Political expediency is not going to solve pressing underlying economic problems.
But discretion is advisable for the central bank, too. The BoE needs to rethink its own approach, particularly on how it winds down the bond stockpile accumulated through its quantitative easing.
The decision taken at its last monetary policy committee meeting on Sept 22 to introduce active quantitative tightening (QT) by actively selling gilt and corporate bond holdings back into the secondary market now looks unwise.
A further delay, after last week’s market meltdown prompted the announcement of a pause until the end of this month, looks like the most sensible option.
Chief economist Huw Pill has repeatedly stipulated that the BoE will weigh market conditions when setting gilt sales.
Surely, the definition of unstable markets has been more than achieved after 30-year gilt yields rose and fell nearly 150 basis points last week. So the temporary delay needs to be extended, with no QT attempted until next year at the earliest.
The bar has been raised for when the central bank can start to actively unwind its balance sheet, which is supposed to filter bonds seamlessly back into the market without causing ripples.
Nearly £40bil (RM223bil) will run off naturally in the coming year from maturing holdings not being reinvested.
With a syndicated auction of a 2038 gilt planned for the final week of the month, likely for more than £5bil (RM23bil), direct competition between the UK Treasury’s Debt Management Office and the BoE is not something the market can handle presently.
A cynic might think that the BoE deliberately chose that week to pressure the Chancellor into bringing forward the assessment from the Office for Budget Responsibility (OBR) on the balance of the government’s finances.
For sure, stability in the gilt market is unlikely to be restored unless there is an earlier read on the OBR’s verdict than the Nov 23 budget, as is the current government plan.
The BoE’s financial stability intervention announced last week, with buybacks of as much as £65bil (RM299bil) of long-dated gilts, is scheduled to run until Oct 14.
It has been hugely successful in swiftly calming the febrile gilt market, and the bank deserves a lot of praise for its competency.
It will be prudent to hold in reserve the available balance for any future action, which hopefully won’t be needed.
There will be a nervous moment when the backstop concludes at the end of next week; the BoE can help steady markets by announcing a further deferral of QT between now and then.
It can then proceed with the more important business of raising interest rates at its next meeting Nov 3 by the “sizeable” amount that Pill has repeatedly flagged.
That should be more important to the BoE’s mission in curtailing inflation than doubling the size of its balance-sheet reduction in the midst of an ongoing market storm triggered by the government’s newfound profligate approach to finances.
The UK financial markets are slowly starting to breathe again after the most volatile week in memory. The government is starting to correct some of its ill-prepared plans.
As the fever abates, the BoE has more work to do to further steady the ship. — Bloomberg
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. The views expressed here are the writer’s own.