The UK Treasury bond market is experiencing agitated hours again, reminiscent of the panic caused last September by the tax cut of the ill-fated former Prime Minister Liz Truss. The profitability of the calls gilts —public debt bonds— has rebounded after knowing, last Wednesday, the new inflation data for the country. At 8.7% in April, the figure was notably below the 10.1% recorded in March, but much higher than many analysts had anticipated.
The Bank of England (BoE) has already decided to change its mathematical model, after successive failed forecasts that prices in the UK would fall faster than they are. “There are important lessons to be learned,” acknowledged the governor of the monetary authority, Andrew Bailey, on Tuesday before a committee of the British Parliament, after admitting the institution’s ruling, which had anticipated an inflation figure of 8.4% for the month of March.
Prime Minister Rishi Sunak himself has been trapped by his promise to halve inflation before the end of the year. Investors now calculate that the BoE will need to continue raising interest rates, currently at 4.5%, to exceed 5% by 2024.
The market response began on Wednesday, but intensified on Thursday. Two-year public debt bonds have seen their yield (yield) could increase up to 17 basis points in a matter of hours. Throughout the week, the increase has reached 60 points. During the crisis generated by the mini-budget —basically, a massive tax cut— of the Liz Truss-Kwasi Kwarteng tandem (the former Minister of Economy) the increase reached 89 basis points. This level of crisis has not yet been reached, but it has reached a level similar to that of the market crisis in 2008 and 2009.
As the yield increases, the value of the bond decreases. Investors anticipate that, with more expensive money, new debt issues will be more profitable, forcing them to reduce the value of outstanding bonds to match that yield.
The government debt, thus, is greater, and investors who accumulate public debt lose value. The interest rate on a ten-year UK government bond is now 4.4%, much higher than Germany’s 2.5% or France’s 3%, and only comparable to 4.3% on bonds. Italians.
“There is lingering fear of runaway inflation in the UK, and there are concerns about the BoE’s supposed ability to deal with this problem,” said Joel Kruger, a market strategist at LMAX Group. The collapse of bonds and the pound sterling last September led to the drastic intervention of the BoE, which launched itself to buy debt and warned, in the style of the whatever it takes (“whatever it takes”) of Mario Draghi, who would act as many times as necessary to stabilize the markets.
Since then, the new government of Rishi Sunak and his finance minister, Jeremy Hunt, have raised taxes and cut public spending. They have managed to transmit calm and credibility to the markets, accompanied by an improvement in relations between London and Brussels, and the beginning of a solution to the constant dispute over the Northern Ireland lace in the post-Brexit era.
The current situation, investors say, points to a quite drastic adjustment, but presumably more orderly. “Markets are still gauging what the BoE will ultimately do, and they are still hesitant. It will take a while for them to digest this latest tremor,” warns the lead manager of the global investment fund Newton Investment Management. The key, in the coming months, will lie in the evolution of inflation —especially core inflation, which excludes food and energy— which, in the United Kingdom, refuses to go down. The IMF has modified its growth forecast for this country in 2023 and no longer predicts a recession, but the rise points to a meager 0.4%.
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