AJ Bell press comment – 28 September 2022
- Long-dated Gilt yields fall sharply as Bank of England fights for control (and credibility)
- Need to intervene shows central bank stuck between fights inflation and recession
- Resumption of Gilt buying – if only temporarily- shows how hard it could be to return policy to ‘normal’ after a decade if ultra-loose, unorthodox methods
“Inflation to the left of them, recession to the right, onward into the valley of unorthodox monetary policy go Bank of England Governor Andrew Bailey and the Monetary Policy Committee,” says AJ Bell investment director, Russ Mould. “Just a week after a lower-than-expected interest rate increase and confirmation of plan to sell Gilts and start Quantitative Tightening, the Bank of England is now buying more of them in what looks like more Quantitative Easing. Suffice to say that some will undoubtedly see this as a further sign of just how much trouble the Old Lady of Threadneedle Street is in.
“Although the Bank has repeated its commitment to this plan today, the need to intervene shows how difficult it is going to be for Old Lady of Threadneedle Street to tighten policy rising rates and shrinking its balance sheet, while also trying to shelter the UK from the danger of recession as those higher interest rates dampen economic activity as well as managing volatility in the stock, bond and currency markets.
“Monetary policy has been taken to unorthodox, ultra-loose levels since 2008 and although central bankers will argue this has worked and help the globe through the Great Financial Crisis, the Greek debt crisis and then COVID, they are now finding withdrawing that stimulus as inflation builds is not as easy as first hoped.
Source: Bank of England, Refinitiv data
“The central bank is buying more long-dated Government bonds, or Gilts, in an attempt to rein in yields and help both Government borrowing costs and holders of the paper in a market that was becoming - to use its words – disorderly.
“Quite how effective this will be remains to be seen, and the subsequent fall in sterling and spike in gold and silver prices suggests that financial markets are far from convinced.
“The pound quickly lost 1% of its value to return to $1.06 and €1.11.
“Gold jumped 1% from its intra-day low to hit $1,632 an ounce and silver popped 1.5% to $18.29 an ounce. Precious metals fans have long since declared their view that we were on the monetary road to perdition, thanks to QE and what they saw as rampant money creation. Gold bugs assert that efforts to reduce the QE stimulus and normalise interest rates will fail and as debt-reliant economies wobble, the policy response will be more QE, lower rates and a loss of faith in central banks.
“Gold bears will argue the metal is an inert useless lump that generates no cash flow and has little real use, so its true value is merely the marginal cost of production. Newmont currently quantifies its all-in sustaining cost as around $1,200 an ounce, some way below where gold trades.
“However, the Bank of England did achieve its objective of lower Gilt yields. The 20-year yield fell by more than 71 basis points (0.71%) to 4.30% and the 30-year by 87 basis points (0.87%) to 4.12% as bond vigilantes were put to flight.
Source: Refinitiv data
“Yet it is not clear how effective this policy will be over the longer term, as the Bank of England remains committed to selling £80 billion of Gilts over the next 12 months to reduce the QE stimulus, shrink its balance sheet and try to rein in inflation.
“It is possible that the Bank sells short-dated Gilts and buys longer-dated ones, in an operation which would look something like the US Federal Reserve’s former Operation Twist or the Bank of Japan’s current Qualitative and Quantitative Easing (QQE) scheme (whereby the BoJ is looking to cap 10-year yields on the Japanese Government Bond (JGB) at 0.25%).
“That 0.25% cap is being tested right now, but at least the Bank of England has not put out a cap on the amount it is buying or its target Gilt yield as bond vigilantes, concerned about rising inflation and increased Government spending, would surely start pressing back against both very quickly.
“The Bank of England programme does seem to have a limited lifespan and is due to end on 14 October. The big test will surely come when the central bank tries to unwind its latest purchases.
“Nor will fixed-income investors be pleased to see how the yield curve is still inverted. The Bank’s inflation-fighting credentials are already looking tatty as it moves to increase interest rates more slowly than other central banks such as the US Federal Reserve., Now, returns to bond buying and its efforts to engineer a soft-landing for the UK economy mean the Bank are still facing questions.
“An inverted yield curve – whereby longer-dated Gilts offer lower yields than shorter-dated ones – usually is a sign that markets expect a recession, because the thinking is such a downturn will force interest rate cuts in the future and that in turn would usually lead bond yields lower.”
Source: Refinitiv data
