Restive Investors Criticise BOE’s Passive Response to Economic Crisis

Restive Investors Criticise BOE’s Passive Response to Economic Crisis

Published: June 28th, 2020

Frustrated investors have been selling-off Sterling and UK government bonds since the announcement late last week of a slowdown in the pace of the BOE’s asset purchases – even while it increased the overall size of the programme by 100-billion-pounds.

The central bank says it aims to shutter the stimulus program later this year, targeting weekly bond-buying levels of roughly 13.5 billion-pounds being spent currently.

Strategists at Nomura International called the announcement a negative for UK assets, asking in an analyst note ‘if the BOE reduces bond purchases by half, who could step in and fill the gap?’

Bank Governor Andrew Bailey added to investor dismay when he said BOE policymakers didn’t discuss yield-curve control or negative interest rates at their meeting this week.

That placed even more pressure on British gilts, while the market’s grumpy response to bank caution suggests UK assets will be at the mercy of shifts in sentiment over the coming days and weeks. Markets are grappling with uncertainties ranging from joblessness, Brexit negotiations, and the expected economic hit brought on by the coronavirus pandemic.

Gilts could face even more pressure from on 29 June, when the UK government’s Debt Management Office reveals its plan for Q3 debt sales.

Fiscal year issuance for the 2020-2021 period is already set to dwarf records set during the 2008/09 financial crisis, with the British economy staring down the barrel of one of the deepest COVID-triggered recessions to hit a leading world economy.

OECD numbers point to a contraction of 11 per cent or more this year, as Westminster struggles to find a smooth exit from lockdown – which was delayed due to political foot-dragging and has led to one of the highest pandemic death totals in Europe.

Too restrained?

Threadneedle Street was one of the first G-8 central banks to take action under the pandemic, cutting rates two times in March ahead of government restrictions on movement and economic activity. Its bond-buying program has already been re-started once, and bank leaders have said as recently as this week that they stand ready to do more if needed.

Analysts at ING London told journalists they expect the bank to pick up the pace of bond purchases if the UK enters another period of market stress like the one seen in March. If push comes to shove, Bank policymakers will do what’s necessary to calm markets.

Other market watchers have focused on risks that BOE executives seem less apt to discuss, from worries about a no-deal Brexit to COVID-19 erupting in a second deadly phase. These economists argue that the economic outlook doesn’t support any slowdown in stimulus.

Overdoing it with too much stimulus constitutes a much lower risk than doing too little, they say. Better to keep the pedal to the floor where bond purchases are concerned, and ease-off later – if and when the economy rebounds.

Different responses in Europe

Investor response to the BOE’s approach was in sharply different from the response seen by the European Central Bank to its stimulus initiatives this month. It announced a larger-than-expected scale-up of its quantitative-easing programme, which pushed Italian bonds higher and narrowed risk premiums across the eurozone.

Analysts at Citigroup said the UK yield curve would likely steepen further against the US, noting that the BOE’s policy stance thus far has been less welcoming than other countries of the Fed’s offer of global support.

Both countries may have to adopt yield-curve control, they said in a note to investors, as reluctance to go down the negative interest-rate route taken by the Bank of Japan and the ECB is driving monetary policy decisions.

The Chief Economist at the Bank of England, Andy Haldane, has argued (and voted) to keep the pace of bond purchases steady, the only member of the monetary policy committee to do so. That could be a signal that more easing could face challenges from within the BOE itself.

Controlling the curve

Strategists at Mizuho International argue that putting yield-curve control measures in place while the curve is in mid-selloff, will require even more bond-buying to provide balance. With investors demonstrating high levels of disappointment, a higher and steeper gilt curve could also hurt assets like equities that are exposed to pound risks.

A poll of business economists released this week said most expected UK economic contraction of greater than 9 per cent this year, followed by growth of just 6 per cent next year. That would put GDP at 3.5 per cent behind 2019 levels.

They’re even less optimistic about the possibility of a bounce-back in growth than the BOE and Westminster’s fiscal watchdog. Both have issued less-than-rosy outlooks that project lost growth being regained by 2021, but neither has included the potential for a second wave of virus infections in its models.

The cost of borrowing in the UK is still at record lows, with 10-year yields hovering at close to 0.2 per cent. British government bonds have fallen across tenors, and the pound looks set for more bad news amid a second week of losses.

The trade talks to negotiate Britain’s final exit from the European Union are also effectively in stasis, with UK representatives playing for time while the EU side struggles to make significant progress.

It’s understood that the UK government is soon to launch a bracing information campaign that will tell companies to prepare for Brexit and assume some upheaval in the immediate aftermath. A cliff-edge departure from the trade agreements and tariff protections EU membership provides is a real possibility, it will say.

In a note to clients, economists at Bank of America said markets are now looking closely at the end-of-June Brexit deadline, and seeing increased risk that the BOE might be compelled to introduce negative interest rates if the pound shows further weakness.

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