Over the coming 13 days the Bank of England (BoE) will pour some £65 billion into the UK bond market to stabilise the faltering UK financial system.
Never in most people’s wildest thoughts would we see a bank, of the BoE’s stature, have to resort to this level of intervention at a time when it has been explicit in its need to fight inflation with higher rates not further stimulus, although this is action is clearly not about stimulation.
This statement said it all:
“Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability. This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy,”
“In line with its financial stability objective, the Bank of England stands ready to restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses.”
This action has at least stabilised the currency seeing GBP/USD back at $1.08, however there is still considerable risk to the pair.
Citigroup, leading into the emergency measures from the BoE put a note with this to say: “We see no near-term end to the UK’s fiscal woes.” And proceed to recommend put strategies with expiries in December that call hasn’t changed.
Why this is all so challenging is the market sees two things in the new stimulus package from the UK government.
- They giving tax cuts to the wealth at a time when inflation and cost of living is a lower socio-economic issue. All that is going to happen is the forewarned interest rate rise from the BoE will hit those that can least afford it and will smash consumer spending even harder than it already is thus seeing a hard recession.
- UK define pensions are heavily wrapped up in UK gilts – higher funding leads these pension funds to sell gilts to meet creditor costs which in turn pushes the market down and pushes the funds closer to the wall as higher repayments become due.
In short, instability. The risk that we are watching a developed economy hit a financial wall is now real. This is why the BoE has had to step in – the question is will it be enough or will the political fallout cause a U-turn from Downing Street? Either way creditability is shot.
What it really means it that the GBP has a huge amount of risk in it. GBP/USD will find it hard to hold the current level even with the BoE stepping. There are also signs that the pause in the USD’s appreciation is temporary and will likely pick up again adding further pressure to the pair. All metrics, momentum and fundamental point to further declines.
The caveat – watch for gapping and snap backs as positions are closed and then reopened. The consensus from FX brokers is $1.05 over the coming 4 weeks.