“Be more forceful”: that’s the message to the Bank of England from the financial community, convinced that only massive policy-tightening to lift rates above those of the Federal Reserve, will stabilize the pound.
The BoE acted on Wednesday to staunch the bond selloff, announcing a plan to buy long-dated notes. While that fueled a record rally in 30-year gilts, the impact to the pound was less clear, with the currency whipsawing but still holding onto the more-than-5% drop against the dollar since Friday’s tax-cut announcements.
For analysts, the bond-buying scheme may not let the bank off the rate-hike hook and some financial experts are still calling for an emergency intra-meeting rate hike to support the pound. They also say the central bank needs to take bolder steps after the government’s unfunded tax cuts and the subsequent gilt market blowup harmed officials’ credibility in fighting inflation.
“This makes a break of parity significantly more likely,” said Kit Juckes, chief foreign exchange strategist at Societe Generale SA. “Confidence is being damaged and that’s dangerous.”
For Valentin Marinov, head of G-10 currency research at Credit Agricole, the bond buying program may have two opposing effects on the pound: It could be positive as it helps soothe gilt-market turmoil, but may also be negative for sterling, as UK real yields are pushed down and the government’s credibility is further put into question.
“There’s a broader issue, which is the loss of credibility in policy making,” said Mohamed El-Erian, chief economic adviser at Allianz SE on Bloomberg Television Wednesday. “Policy makers will have to go beyond what they would normally would’ve had to go as the Fed is doing in the US.”
El-Erian added the BoE needed to raise rates by at least 100 basis points prior to the meeting, saying an even bigger hike of 150 basis points before then “is not off the table.”
But the BoE has played down chances of such a move which would have evoked memories of the 1992 Black Wednesday crisis, leaving pound-watchers at banks and asset management firms in anticipation for the Nov. 3 meeting.
At that meeting and subsequent ones, policy makers would need to outdo the Federal Reserve in hawkishness, analysts reckon. That means taking the key rate to about 6%, above estimates of the 4.4% terminal Fed rate that’s currently priced. Money markets are pricing some 160 basis points of BoE tightening next month.
The pound briefly jumped after the BoE announcement and then resumed losses. It strengthened again heading into US afternoon trading as the dollar slid against most major currencies.
“Watching the pound today is going to be just crucial,” said Jens Nordvig, founder of New York-based research firm Exante Data, on Bloomberg Surveillance Wednesday. “If the pound can’t take this announcement, maybe the BoE has to take another emergency announcement soon to deal with the pound.”
BoE’s governor Andrew Bailey said the MPC won’t hesitate to raise rates as much as needed, but the remarks did little to reverse the selloff that pushed the pound to the weakest on record and spurred talks about parity to the euro and the dollar.
“They need to raise rates a lot,” said Shahab Jalinoos, chief FX & Rates strategist at Credit Suisse Group AG in New York, who thinks the BoE should deliver an emergency hike before its next scheduled decision in November. “It would break the back of this psychology of the BoE being a laggard central bank.”
Jalinoos said that, from the perspective of pound stability, he would like to see the BoE hike by 100 basis points right away to get the base rate lined up with the current Fed rate of 3.25% and validate market expectations a more than 4% UK rate premium by the first quarter of 2023. “The BoE never delivers what’s priced in so they need to change that perception,” he said.
Deustche Bank’s global head of foreign-exchange research George Saravelos said raising rates above 6% is what markets now demand to stabilize the pound. “If this isn’t delivered, it risks further currency weakening, further imported inflation, and further tightening, a vicious cycle,” he said.
The pound collapsed after Chancellor of the Exchequer Kwasi Kwarteng on Friday announced plans to cut taxes, touching a record low of 1.0350. UK government debt yields also have skyrocketed in the days after before easing on Wednesday after the bond buying announcement.
Rupert Harrison, a portfolio manager at BlackRock Inc. and former adviser to then-Chancellor of the Exchequer George Osborne, said the rout on the pound may not be over.
“Just because sterling has fallen a long way doesn’t mean it automatically has to bounce back medium term,” said Harrison at a webinar on Tuesday. “I think this could still be part of a more medium downward drift.”
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