UK warned ‘significant’ rate rise is coming, as calls for mini-budget U-turn rise - as it happened

A late PS: the selloff in the UK bond market is continuing at a worrying pace tonight.

The yields of UK five, 10 and 30-year gilts have all surged alarmingly, as investors continue to demand a higher rate of return for holding British debt.

Time for a recap.

UK houseowners have been warned to expect a painful hike in interest rates by the first week in November, in response to the market mayhem caused by the Bank of England’s

The Bank of England’s chief economist warned that “significant” increases in interest rates will have to be imposed by the central bank in response to tax cuts put forward by Kwasi Kwarteng in his mini-budget.

The Bank’s chief economist, Huw Pill, said the chancellor’s planned tax cuts would act as a stimulus and increase inflationary pressures, with the result that interest rates would need to go higher than previously forecast.

He said:

“In my view, a combination of the fiscal announcements we have seen will act a stimulus to demand in the economy,”

“It is hard not to draw the conclusion that this will require a significant monetary policy response.

That implies a steep hike in Bank Rate, which is currently 2.25%.

Hundreds of mortgage deals have been removed from the markets in recent days, as brokers are unable to price them given the turbulence in the bond markets.

The next week or so will crucial in determining how the markets plays out.

Chancellor Kwasi Kwarteng has tried to reassure international investors, telling them that he has confidence in his economic plan.

“We are confident in our long-term strategy to drive economic growth through tax cuts and supply-side reform,” Kwarteng told bosses, according to a Treasury readout of the meeting.

“I’m confident that with our growth plan and the upcoming medium-term fiscal plan – with close cooperation with the Bank [of England] – our approach will work.”

UK government bonds are continuing to weaken after international investors’ confidence in Britain was hammered. The yield on long-dated 30-year bonds is the highest since before the 2008 financial crisis.

It now costs the UK more than Italy or Greece to borrow for the next five years.

More experts have warned that the government should u-turn on the tax cuts announced in Kwarteng’s £45bn giveaway.

The boss of Virgin Atlantic, Shai Weiss, said Liz Truss should take a “difficult decision” to reverse sterling’s slide, arguing:

“Sometimes all of us in this room should be humble enough to say: ‘If I did something that is not working, maybe I should reverse course.’

“That is not a bad thing to do.”

German finance minister Christian Lindner raised doubts about the British government’s plans to accelerate spending while the central bank tightens policy to rein inflation.

In another sign of rising international concern, Lindner warned:

“In the UK, a major experiment is starting as the state simultaneously puts its foot on the gas while the central bank steps on the brakes,”

And Larry Summers, a former US Treasury secretary, warned that the UK government’s ‘utterly irresponsible’ plans could drag the pound below parity against the euro, as well as the dollar.

Victoria Scholar, head of investment at Interactive Investor, says concerns that Kwarteng is acting irresponsibly are rising:

Adding to the damaging market reaction on Monday, the backlash against the mini-Budget appears to be widening amid complaints from the corporate sector as well as policymakers in the US and Europe.

The common thread that ties together the slew of grievances seems to be a sense that the Chancellor is acting experimentally and irresponsibly in a way that is creating major risks to UK financial markets as well as its economic outlook. Former US Treasury Secretary Larry Summer, the German finance minister Christina Lindner and Virgin Atlantic’s CEO Shai Weiss have all commented publicly on the new economic direction laid out by the new UK government with deep scepticism.

Weiss alongside JP Morgan economist Allan Monks have argued that the fiscal strategy should in fact be reversed or reconsidered.

The pound is calmer today, hovering below $1.08 against the US dollar.

And Sky News are reporting that Liz Truss had to be convinced that the government should issue a statement yesterday to calm the markets.

We’ll be back tomorrow…. GW

Rightmove have warned that the average monthly mortgage payment for a household buying a first-time buyer home would rise to £1,302 if the average mortgage rate rose to 6%, as looked likely yesterday.

That’s based on taking out a two-year fixed mortgage, at 90% LTV (ie, with a 10% deposit).

They add:

This monthly payment would be 60% higher than those getting on the ladder at the start of 2022.

For two people buying a first home together and splitting the £1,302 payment, the monthly payment each of £651 would equate to 25% of their gross average salary, up from 15% at the start of the year.

27 Sept 202210.58 EDT

Ireland lifts spending in budget, but avoids UK-style splurge

Rory Carroll

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Ireland has unveiled a budget that ramps up spending and gives tax relief but pales in comparison to the UK’s blowout, our Ireland correspondent, Rory Carroll, reports from Dublin.

The finance minister, Paschal Donohoe, announced measures worth more than €10bn today to cushion households and businesses against rising prices but held back from a full-throttle fiscal expansion.

He told the Dáil.

“It is essential that we use our surpluses wisely – we should not spend everything today to ensure that we are ready for tomorrow.”

The government earmarked about €1bn to tweak the 40% top tax rate so that it will apply to income above €40,000, rather than €36,800.

The lion’s share of the spending will be on extra welfare payments, energy credits, public transport subsidies and rent tax credits.

The British Irish Chamber business group welcomed the budget for replenishing the nation’s “rainy day fund”.

“While the fund is far from enough given the volatility of corporation tax, the move will allow the country to think long term and prepare for future risks and liabilities like interruptions to trade and supply chain issues.”

Commentators had urged the centre-right coalition government to avoid a UK-style splurge.

The Irish Times said:

“The message sent out by the budget needs to be one of stability and a credible plan for the public finances.”

Sky News have an eye-catching story, that Liz Truss had to be convinced that the government should issue a statement yesterday to calm the markets.

The prime minister’s initial instinct had been to stand firm and say little or nothing as the pound hit a record low, and government bonds slumped, according to Sky’s deputy political editor Sam Coates.

He writes:

Faced with market turmoil, spiking borrowing costs, and the drop in the value of the pound in the foreign exchange markets, the prime minister’s initial instinct was to stand firm and say little or nothing, unwilling to look like she might be shifting position.

However, after a meeting with Chancellor Kwasi Kwarteng yesterday, Ms Truss agreed the Treasury would issue a statement promising further details on 23 November on how the government would ensure borrowing would not spiral out of control.

Coates adds that the government will reject claims circulating in Whitehall that the meeting between Ms Truss and Mr Kwarteng was “argumentative” and descended into a “shouting match”.

Here’s the full piece.

Huw Pill’s prediction of a ‘significant’ response to the mini-budget (and the resulting market mayhem) is going to alarm homeowners who need to refinance a mortgage next year.

Rates are clearly heading up, sharply, unless the situation changes dramatically.

My colleague Zoe Wood explains what it will mean:

It depends what type of deal you are on. Most borrowers are on fixed-rate mortgages, so are insulated from the upheaval for the time being. However, the upshot of all this is less choice and higher borrowing costs when you do need to find a new deal.

Someone who fixed at 2% two years ago could be looking at a remortgage rate at 5% by next week. If they had a £200,000 mortgage over 25 years, that’s a rise in monthly payments from £848 to £1,169 – or £321.

About a fifth of households are on a variable rate – either a tracker mortgage, where the rate you pay is explicitly linked to the Bank base rate, or their lender’s standard variable rate (SVR). Amid the announcements that products were being withdrawn Halifax and Scottish Widows Bank said their SVR was going up by 0.5% to 5.74%.

Higher mortgage costs are also bad news for first-time buyers who may have to lower their budget in order to manage repayments on the loan.

If you have six months or less to run on a fixed-rate mortgage it might be wise to start shopping around for a new rate. Given the market turmoil, you may want to talk to a broker who understands the fast-changing mortgage sector outlook and can track down the best rates.

Imran Hussain, a director at Harmony Financial Services, predicted mortgage products will “get chopped and changed quicker than we can all keep up”. “The mortgage market was already hectic and now it’s going haywire,” he said.

Here’s the full piece:

The FTSE 250 share index has dropped to a new 22-month low, extending its losses following Huw Pill’s speech.

The FTSE 250 contains more domestically-focused firms than the blue-chip FTSE 100, making it more vulnerable to a British economic downturn.

It’s down 1.5% today, at levels last seen in November 2020 (before the first successful Covid-19 vaccine results).

Real Estate Investment Trusts, which own UK property assets, are among the top falls – some down over 7% today.

That shows that their underlying assets, such as shops and warehouses, have fallen in value due to the looming surge in interest rates.

Huw Pill added that while the BoE’s next scheduled policy announcement (on the first Thursday in November), seemed like a long way away, it is better for central banks to take a “more considered approach, a lower frequency approach,”

In the meantime the BoE would rely on communicating its intentions, the BoE’s chief economist added.

That strategy could some under serious market pressure over the next five weeks, though. If the pound starts sinking to new lows, nearer to parity, the Bank will face more calls for action.

Overnight, a former BoE policymaker, David Blanchflower, predicted that the markets would force the UK’s top fiscal and monetary policymakers into a change of heart:

The Bank of England is likely to deliver a “significant policy response” to last week’s announcement of tax cuts by finance minister Kwasi Kwarteng, its chief economist says.

But Huw Pill also argued that the Bank should wait until its next scheduled meeting in the first week of November (rather than through an emergency rate hike).

Pill told the CEPR Barclays Monetary Policy Forum that:

“It is hard not to draw conclusion that this will require a significant monetary policy response.”

A ‘significant’ response is central bank-speak for a large interest rate rise.

Pill explains that the Bank’s monetary policy committee is not indifferent to the repricing of financial assets [which have plunged alarmingly since Friday morning’s mini-budget].

And he said he wanted to ‘flag clearly’ that the government’s fiscal announcement will “act as a simulus”.

That’s a sign that Pill thinks monetary policy must respond to Kwarteng’s tax cuts plan, with higher interest rates.

The surge in UK long-dated bond yields is quite serious…..

Kwarteng’s comments haven’t brought any obvious relief to the bond market.

UK gilt prices are falling again, pushing up the yield (or interest rate) on 10-year gilts to the highest since late 2008, at 4.377%

The 30-year gilt yield has continued to rise, hitting the highest level since 2007 at 4.838%.

The gap between UK and safe-haven German government debt has widened too – to the most since 1991.

That shows that investors are imposing a higher risk premium to hold UK assets, as confidence in Britain remains in shorter supply.

Indeed, it costs London twice as much as Berlin to borrow for a decade. UK 10-year gilts are trading at a 4.28% yield, compared to just 2.15% for German bunds.

Here are some photos from Kwasi Kwarteng’s meeting with top bosses from the UK’s financial services industry.

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As flagged earlier, the meeting was meant to be a polite conversation about Kwarteng’s plans to unleash growth. It looked rather more fraught due to the plunge in sterling, and the surge in bond yields.

As Bloomberg reported this morning, before the meeting:

Two veteran financiers said the chancellor’s offhand tone also appeared to ignore the seriousness of loading Britain up with debt. That will have rattled watching investors, they added, complaining that Kwarteng - who did a PhD thesis on a 17th-century sterling crisis - hasn’t shown enough willingness to be guided by what’s actually happening in the markets.

That won’t help as he turns to the City for assistance selling the £100 billion ($106.5 billion) or more in government bonds needed to fund his plan, they added.

The chancellor also insisted that he was right to announce tax cuts last Friday, telling leading bankers, insurers and asset managers that:

“We have responded in the immediate term with expansionary fiscal stance on energy because we had to. With two exogenous shocks - Covid-19 and Ukraine - we had to intervene. Our 70-year-high tax burden was also unsustainable.

“I’m confident that with our growth plan and the upcoming medium-term fiscal plan - with close co-operation with the Bank - our approach will work.”

But as you already know far too well, almost all those tax cuts go to the richest 5%….

Kwasi Kwarteng also told City investors that he will produce a ‘credible plan’ to start bringing down debt, as a share of the economy, at his planned statement in November (two whole months away…)

“Cabinet ministers will set out more supply-side measures over coming weeks to make meaningful change. Right across Government, departments have to be focussed on this.

“As I said on Friday, every department will be a growth department.

“We are committed to fiscal discipline, and won’t re-open the spending review. We have a Medium Term Fiscal Plan coming on 23 November, alongside an OBR forecast. That will be a credible plan to get debt to GDP falling.

UK chancellor Kwasi Kwarteng has told leading bankers, insurers and asset managers at today’s meeting that he is “confident” that his economic strategy will work.

In his meeting with City chiefs this morning, Kwarteng said he was confident that the long-term strategy to drive economic growth through tax cuts and supply side reform would work.

In an attempt to reassure the City of London, rocked by days of turmoil, the chancellor reiterated the government’s commitment to fiscal sustainability (days after annoucing unfunded tax cuts that will require a surge in borrowing…).

He also argued that supply side reforms would cool inflation, as increased capacity brings down prices.

Kwarteng said:

“I’m confident that with our growth plan and the upcoming medium-term fiscal plan — with close co-operation with the Bank — our approach will work.”

It shows that Kwarteng plans to stick to his economic strategy in the face of a market selloff that sent the pound crashing.

But of course it’s the confidence of international markets – not the chancellor – that really matters, and will determine whether the crisis abates, or intensifies.

What would it take to prompt the Bank of England into an emergency rate hike, ahead of their scheduled meeting in early November?

Professor Costas Milas of the University of Liverpool’s Management School tells us that a credit rating downgrade could be a possible trigger for emergency action to boost sterling.

He explains:

I believe that the Bank of England will have to act if credit rating agencies (CRAs) downgrade the UK sovereign debt. This, in my view, is likely. CRAs usually take action when either economic policy uncertainty rises significantly and/or debt rises to unsustainable levels.

Economic policy uncertainty (measured here) is at its highest level since the beginning of the COVID-19 pandemic.

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This is ‘hammering’ both the sterling effective exchange rate and sterling against the dollar. At the same time, UK debt will rise significantly following the chancellor’s min-Budget.

What remains to be seen is how high the UK debt will go since, currently, we do not have official estimates of the additional debt burden. Something that will tempt CRA’s to think seriously about a credit rating downgrade.

The Treasury and the Bank of England could, and should, have done a better job in helping the UK through the very difficult winter ahead, argues Dario Perkins, managing director for Global Macro at TS Lombard.

Perkins, a former Treasury economist, has also argued that the UK is now suffering from a “Moron Risk Premium” (MRP).

Basically, because the markets think government policy is fundamentally incoherent, and don’t trust the Bank of England to step in, they downgrade UK assets across the board, from the pound to gilts.

Economist Jonathan Portes has covered this compelling theory in the i, here.

As an aside, Perkins also came up with the superb “Paolo Maldini guide to central banking”, coined after the legendary defender known for his superb positioning and timing.

The idea is simple: once inflation is a problem, there is no real chance of a “soft landing” because the central bank has already messed up.

More here: Don’t Bet On A Soft Landing

These days, Italian defenders use cruder tactics when they’re caught out of position – and the Bank may have to do the same to pull back runaway inflation….

This is an important point about the pound’s modest recovery today: