The Bank of England raised the limit on gilt purchases to £10bn a day on Monday, doubling the firepower to help prop up debt markets. It also eased collateral requirements for banks to ease pressure from margin calls in the pensions industry.
That doesn’t seem to have settled the markets. Yields on 30-year gilts jumped another 18 basis points to 4.56% after the announcement. Half of the yield compression since the Bank unleashed its bazooka two weeks ago has evaporated.
The program is due to end on October 14. International investors will likely see any extension of the gilt program beyond that date as a step across the Rubicon, a shift from a liquidity operation to something more like a government fiscal bailout. .
The rise in 30-year yields is worrying as Sir Jon Cunliffe, Deputy Governor of the Bank of England, cited the initial fall in these yields as the stamp of market approval for the emergency intervention.
It is also a surprise as the Bank has only spent £5bn on the £65bn facility so far.
David Owen of Saltmarsh Economics said: “Some people in the market may wonder if the Bank of England knows something that we don’t.
“I think it’s really to ensure an orderly transition during a busy week for data, just in case pension funds run into trouble at the end of this week and need to liquidate positions. But international investors don’t maybe not see it that way.
Mr Obstfeld’s warning is unexpected as he is generally seen as a dove in global circles and recently warned against monetary overexploitation by central banks. His call for an immediate rate hike is a sign of Britain’s tarnished credibility.
“It was unwise to deploy tax cuts without the necessary analysis and respect for institutions. The message was that ideology trumps everything else,” he said.
Mr Obstfeld said the rollback of the top tax rate was a valuable ‘stabilizer’, not because the sums are relevant – just £2bn of the £45bn package – but rather because ‘it signals an awareness of growing political risk.
He said: “The whole Covid experience has put a strain on social cohesion and people are going through very difficult times. Economists are now more attentive to the distributive effects of crises.
This is the wrong historical moment for neo-Thatcherism.
However, undoing the 45 pence rate cut is not in itself sufficient to rein in inflation or put the long-term trajectory of public debt on a sustainable path.
Mr Obstfeld said the Bank must walk a fine line as the structure of the UK mortgage market makes the economy very sensitive to interest rate hikes.
Most mortgages in the United States, France or Germany are fixed rate with a term of 25 or 30 years. The UK is an outlier that relies heavily on floating rates. Most fixed offers are actually floating rates with a two-year teaser.