You only had one job…

Andrew Bailey, Governor of The Bank of England (BoE), has stated there are ‘very big lessons to learn’, after failing to spot the current inflationary bubble. The Monetary Policy Committee (MPC) is primarily responsible for keeping the Consumer Price Index (CPI) measure of inflation close to a target, currently 2% per year.

Having faced criticism for failing to act soon enough to tackle inflation, the BoE has just secured the services of Ben Bernanke, former Chair of the US Federal Reserve, to review why the central bank got its inflation modelling so wrong. The urgent review will begin this Summer, with findings due to be published in the Spring of 2024.

However, when it rains it pours. The BoE has revealed that UK public finances face a £150bn bill to cover losses resulting from its Quantitative Easing (QE) programme over the next ten years. QE was introduced by leading central banks as part of a co-ordinated solution to the global financial crisis. Besides cutting interest rates to a record low, central banks introduced QE to stimulate the global economy. The BoE purchased some £895bn of bonds between 2009 and 2021.

The BoE is indemnified against losses on the QE programme under an agreement signed with the Treasury in 2009. However, transfers between the BoE and Treasury will have consequences for UK taxpayers.

The BoE estimated that the additional interest rate burden on its QE bond portfolio would be £100bn, but has now raised this to £150bn, as UK interest rates are expected to move up to 5.75%. In the short term, the BoE has increased estimates that it expects the Treasury to transfer over about £40bn per annum, for the next three years.

This news comes at a time when public finances are already under, pressure due to the previous support required to cope with the Covid-19 pandemic and energy crisis following Russia’s invasion of Ukraine. Credit Agency Fitch, estimates that UK debt interest rate payments in 2023 will be £110bn or 10.4% of total government revenue, the highest level of any ‘high-income’ country. Furthermore, a quarter of UK government debt is in the form of index-linked Gilts, where the interest payments move in line with inflation. Ouch!

Markets became addicted to QE and it was clear that as soon as central banks shifted from QE to policy tightening, that there would be a painful period of adjustment. Just how painful that would be is only just starting to become clear. Many businesses and consumers that have only known an ultra-low interest rate environment are now having to face a period of higher interest rates for longer.

Last week, the Bank of England said it would make sure interest rates are ‘sufficiently restrictive for sufficiently long.’

 

What have we been watching?

 

Markets went into reverse last week due to increased risk aversion following a credit agency ratings downgrade of US sovereign debt. The US 10-year Treasury yield moved up from 3.95% to 4.2% before retreating to 4.08%. The Bank of England delivered the expected interest rate hike and Sterling remained around $1.27. The latest monthly PMI business activity indicators from a number of Asian and European countries remained weak.

The market mood was not helped by a jump in uranium prices due to the coup in Niger which is the EU’s second largest supplier. Russia is believed to control 40% of the world market for nuclear fuel. Markets remain sensitive to inflationary higher energy costs. Meanwhile, copper and iron ore prices continued to retreat as hopes of Chinese economic stimulus measures waned.

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In the UK, house prices dropped by 3.8% in July, the fastest annual pace of decline for fourteen years according to the Nationwide. Meanwhile, there was some encouraging news on inflation as food prices slowed for the third month in a row in July to 13.4%. The Bank of England (BoE) announced the expected 0.25% increase in interest rates to 5.25%. The BoE believes the UK will avoid a recession but trimmed its economic growth forecasts for 2024 and 2025 to 0.5% and 0.25% respectively. The 2024 inflation forecast has also been trimmed to 2.25%.  Markets continue to expect at least one further 0.25% interest rate hike from the BoE. 

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Credit agency Fitch downgraded US sovereign debt from AAA to AA+ on the back of the growing federal debt burden and an erosion of governance resulting in multiple gridlocks over the debt ceiling. US Treasury Secretary Janet Yellen said the Fitch downgrade was ‘entirely unwarranted and puzzling in light of the economic strength we see in the US.’

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The Bank of Japan intervened twice last week in an effort to slow down increases in sovereign bond yields.

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China’s Caixin manufacturing PMI dropped into contraction with a reading of 49.2, a six-month low. The Caixin services sector PMI made for better reading ticking up to 54.1 in July.

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Brent oil initially dipped to $83 alongside other commodities on the US debt downgrade but closed the week up at $86 supported by the Saudi Arabian production cut.

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Finally, another reason electric cars might not be quite as environmentally friendly as first thought. A ship carrying 2,857 cars recently caught fire off the coast of Holland. The fire is believed to have been started by one of the 25 electric cars on board the vessel. Following several such incidents, The International Maritime Organisation is now considering new safety standards at sea for vessels transporting electric vehicles although this may take some years to implement.

Read Last Week’s Alpha Bites – A Latin love affair

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.