Aurelia Butler

The Bank of England warned that households face the worst squeeze on their disposable incomes for at least 30 years, with inflation rising to 7.5 per cent, economic growth slowing, unemployment rising and taxes going up. Setting out a dark picture for the economy, the BoE’s Monetary Policy Committee raised interest rates by a quarter point to 0.5 per cent, the first tightening of monetary policy in consecutive meetings since 2004.The European Central Bank also voiced fears about inflationary pressures. Its president, Christine Lagarde, refused to rule out raising interest rates this year, citing what she said was “unanimous concern” about inflation. In the UK, the squeeze on incomes will hit hardest in April when the typical gas and electricity annual bill rises 54 per cent to almost £2,000 from £1,277 today. Chancellor Rishi Sunak, who announced a £9bn package of support to hold down bills, admitted at a Downing Street press conference that “energy markets are forecasting that prices go up further in October”. Analysts expected the energy price cap could rise to as much as £2,450 per household in October. But Sunak said the support he was announcing was intended to last “over the year”. He said markets expected prices to fall “quite significantly” by spring next year. BoE governor Andrew Bailey said the hit to household incomes was not sufficiently severe to bring inflation down. Delivering what he said was a “hard message” on the cost of borrowing, he admitted that the rate rise “will be felt by households and businesses across the UK”. With a rise in national insurance and income tax also coming in April, BoE officials calculated that the real value of labour incomes after tax would fall 2 per cent in 2022, the tightest squeeze in any full year since equivalent records began in 1990.Bailey urged the employed not to respond by seeking higher pay settlements because price rises would become ingrained in the economy and lead to “a longer period of high inflation”. The BoE also cut the growth forecast for 2022 from 5 per cent to 3.75 per cent before settling at a “subdued” pace of only 1 per cent into the medium term. Unemployment is forecast to rise from a low of 3.8 per cent to 5 per cent as the economy struggles to shed its inflationary tendencies.

Financial markets expect interest rates to rise faster and further, with traders pricing in an increase in official interest rates to at least 1 per cent by May, and 1.5 per cent by November.To mitigate the pain, Sunak unveiled a £9bn package support for households with a £200 rebate on energy bills for all households coming in the autumn, but repaid over the following five years. Those with properties in council tax bands A to D would also have a £150 reduction in their bills this year. The chancellor said this was a “fair, targeted and proportionate” package of support.But opposition MPs and campaigners said the support would do little to offset the combined energy and national insurance increases that will leave typical households £1,300 out of pocket. Labour called the universal energy bills rebate a “buy now, pay later” scheme. More

Few governments would be able to survive a hit to voters’ living standards like the one facing Britain over the coming months. First there is the increase in the price cap that limits the amount energy companies can charge their customers. Then UK households face tax rises, in the shape of a scheduled increase in national insurance and freezes in the main thresholds for income tax. To cap it all, the 0.25-point base rate rise from the Bank of England on Thursday — its first back-to-back rise since 2004 — will mean higher mortgage costs. All this is a recipe for a year of stretched household budgets and economic misery for millions. For a government under as much pressure as the one led by Prime Minister Boris Johnson — facing calls to resign over parties that breached coronavirus rules — it risks being existential. So it is understandable that chancellor Rishi Sunak wants to widen the scope of the social safety net. Instead of targeting support solely at those who face a choice between “eating and heating”, he is sending more money to middle and higher earners who will also see their spending power fall over the coming year.To help reduce the impact of the energy price cap increase — estimated to add about £700 a year to a typical household’s bills — Sunak announced programmes costing about £9bn. One key element is a £150 rebate on council tax — totalling £3.6bn — in April for each property in the lowest four tax bands in England; money will be made available to the UK’s devolved governments to offer similar schemes. The chancellor estimates that will cover 80 per cent of households. In addition, all bill payers will receive a flat £200 discount on electricity bills in October — costing £5.5bn — that Sunak intends will be recouped by adding £40 annually to bills for five years from 2023.The government deserves credit for resisting siren calls to cut the 5 per cent rate of value added tax on energy bills. While that would have political appeal — it could be sold as a benefit of Brexit as the EU’s rules limit how much the tax can be cut — it would have mostly benefited the better-off. Richer households tend to spend more on heating in absolute terms, thanks to larger houses, but poorer ones spend more as a proportion of income. A VAT cut would have done little for those who need it most. Similarly, a mooted cut in “green levies” would have done more to reassure rightwing backbenchers than address the problem. If anything, the UK’s vulnerability to higher gas prices underlines the costs of a decade’s failure to insulate its draughty homes, a necessity to hit its net zero target by 2050. Even so, the package could have been better targeted. The council tax bands being used are based on property valuations from 1991. That makes them a worse measure of “need” than the existing welfare system — many young professionals live in formerly cheap accommodation in London, for example. Sunak is, rightly, increasing the scope of the existing warmer home discounts scheme — where energy suppliers give discounts to needy customers — but making it even more generous would be a better use of scarce resources. The government is taking a punt on energy prices eventually falling. While it is sensible to smooth the impact of the gas price rise, the Treasury has no special powers to forecast the cost of gas next year, and the higher bills from which Sunak intends to recoup the cost of this year’s discount may equally come at a bad time. The chancellor’s moves are unlikely to be the last time the government has to intervene to ease the cost of living crisis. More

Christine Lagarde refused to rule out raising interest rates this year in response to the European Central Bank’s “unanimous concern” about soaring prices, fuelling increased investor bets that it will raise borrowing costs several times in 2022.The ECB president said inflation risks were “tilted to the upside” after annual consumer prices in the eurozone rose by a record 5.1 per cent in January. She backed away from earlier comments playing down the chances of the bank raising rates in 2022 because of “the situation having changed” and said it was “getting much closer” to hitting its target on inflation.Lagarde said there was “consensus” among ECB policymakers on its decision to keep rates unchanged and to pursue a “step-by-step” reduction in bond purchases this year. But a person familiar with the council said “one or two” of its members had called for an immediate tightening of policy.In response to Lagarde’s comments during a press conference after the ECB governing council met on Thursday, investors increased their bets that the central bank will be forced to change course and raise rates several times this year.Konstantin Veit, portfolio manager at Pimco, said the ECB’s “hawkish message” signalled “more openness towards an earlier withdrawal of monetary policy support”.The euro jumped to a more than two-week high against the dollar and a sell-off in eurozone bonds intensified after Lagarde declined to explicitly rule out an interest rate rise this year. The single currency was up 1.2 per cent at $1.143.Germany’s 10-year yield, a benchmark for financial assets across the eurozone, surged to a nearly three-year high of 0.14 per cent. Traders increased their bets on higher interest rates, with markets pricing in a rise in its deposit rate from minus 0.5 per cent to minus 0.1 per cent by December after Lagarde’s press conference.While the ECB left policy unchanged, her comments were widely interpreted as signalling a likely shift to tightening monetary policy as early as March. Carsten Brzeski, head of macro research at ING, said Lagarde’s “hawkish backward roll” had “opened the door to a speeding up of asset purchase reductions and a rate hike this year”.Lagarde said there had been “unanimous concern around the governing council table about the impact of inflation” on Europeans and their “day-to-day hardship of having to put up with higher prices”.She said the ECB would stick to the “sequence” it had already announced of only raising rates after it stopped net bond purchases, adding that the council would be “gradual in whatever we do” and “not be rushed into anything”. But she raised expectations that the ECB will again raise its inflation forecast at its next policy meeting in March, bringing it up to its 2 per cent target for the next two years and leading to a quicker removal of its stimulus than planned. This could lead to it accelerating plans for stopping net asset purchases in preparation for the first increase in its deposit rate for more than a decade.Frederik Ducrozet, strategist at Pictet Wealth Management, said Lagarde had delivered a “reality check” for bond markets. “The risk scenario is now clear: large upward revisions to staff projections in March, a faster tapering ending net asset purchases by the third quarter, and a rate [rise] in the fourth quarter of 2022,” he added.Higher than expected inflation has led the US Federal Reserve and the Bank of England to shift to more “hawkish” policy stances. The BoE raised its main policy rate to 0.5 per cent on Thursday, less than two months after increasing it to 0.25 per cent, while investors are pricing in five rate rises by the Fed this year. After the ECB press conference, Italy’s 10-year bond yields rose about 20 basis points to 1.66 per cent, their highest since May 2020. James Athey, investment director at Abrdn, said: “The ECB is opening up a potentially huge hole for Italian bonds to fall into.” More

Last week the government in Argentina received a badly-needed boost: the IMF finally agreed to restructure a $57bn loan, averting an imminent default. That is good(ish) news for Alberto Fernández, the country’s president. It is also a face-saving reprieve for IMF staff, given the history of the fund’s embarrassing failures around Argentina.For global investors, however, the deal should be a wake-up call — and not just because it underscores the intractable nature of Argentina’s unaddressed structural woes. It also poses a far bigger question: what will happen to the rest of the world’s troubled sovereign debt this year, particularly among the poorer countries that cannot count on this scale of IMF largesse?The issue is alarming for three reasons. First, western politicians and voters have been depressingly complacent about the scale of economic and human pain that the pandemic has inflicted on poor countries in the past two years. The news from Argentina, for example, barely garnered any headlines. Second, while this pain has been largely ignored in the west, it is getting worse. So much so that David Malpass, World Bank president, warned last month that the world is now heading into a swath of “disorderly defaults” among poorer nations.Meanwhile, the IMF reckons that 60 per cent of low-income countries now face debt distress. This is double that of 2015. Investors are bracing for potential defaults by LICs such as Sri Lanka, Ghana, Tunisia and El Salvador — as well as middle-income countries such as Lebanon, Turkey and Ukraine. Rising US interest rates will make the pressure on these countries worse.The third big problem, though, is that the financial processes to resolve and restructure these debts are fraying. During the second half of the 20th century, the western world organised restructurings of poor-country debt by using the “Paris Club” framework. This enabled creditor nations to cut deals backed up by institutions such as the IMF and the “London Club” of commercial lenders.Such a western-centric approach no longer works. A startling IMF chart shows why: a decade ago, low-income countries had about $80bn of public external bilateral debt (excluding multilateral and private loans). Two-thirds emanated from Paris Club lenders. Today, these debts top $200bn, and under one-third is lent by the Paris Club. The rest is mostly owed to China, which has expanded its liens so frenetically that it is now “the largest lender to the emerging markets”, as a new, hard-hitting report from a Bretton Woods committee of financial luminaries notes.This radical change makes the Paris Club mechanism less relevant, particularly since the nature and scale of those Chinese loans is deeply opaque. AidData, a US research group, thinks that emerging market countries have another $385bn of hidden Chinese debt, which is uncounted in official statistics. The situation in Zambia illustrates this problem. Two years ago western creditors tried to negotiate a settlement for its debt, but because Zambia refused to disclose its Chinese debts there was “a level of distrust that made it virtually impossible to make progress on the country’s restructuring”, the Bretton Woods report notes. Worse still, there are swelling, and opaque, exposures to private sector companies and hedge funds. Many of those lenders are increasingly aggressive. Efforts to restructure Chad’s debts, for example, have been complicated by its loans from Glencore, the mining group.Is there any fix? The Bretton Woods report argues that one crucial step would be for governments to create a unified, transparent database of their debts. It calls on rating agencies, multilateral banks and investors with environmental and social governance mandates to lobby for this. It also argues that the old Paris Club framework should be overhauled to give China a proper seat at the table. Finally, it calls for private sector lenders to be incorporated into negotiations at a much earlier stage.This is entirely sensible. Moreover, these ideas are supported by bodies including the IMF, which has been trying, and largely failing, to create a more rational framework in recent years. But the real uncertainty is whether the Group of 20 nations in general, and China in particular, will play ball. The IMF is now imploring the G20 to take action. Kristalina Georgieva, head of the IMF, thinks — or hopes — that this progress could occur this year, particularly since Indonesia is the incoming chair of the G20. “Indonesia has a better chance of getting emerging market countries and China into [an] agreement,” she told the Financial Times this week. Yet the Beijing government seems internally split about whether to co-operate. Moreover, the history of the G20 suggests that it is such a reactive group that it is unlikely to take action until there is a full-blown debt crisis on its hands. That, of course, is the last thing a pandemic-scarred world needs. Hence the reason why western politicians, not to mention investors, urgently need to heed Argentina’s message. Although it might seem tempting to keep papering over poor (and not so poor) countries’ debt problems, this will not magically fix them. Let us pray that Indonesia can work some magic. [email protected] More

A sharp sell-off swept global bond markets on Thursday, as investors responded to signals that central banks in the UK and the eurozone are stepping up their inflation-fighting efforts.The Bank of England sparked steep declines for UK government debt when it raised interest rates for the second consecutive meeting, with a sizeable minority of rate-setters voting for an aggressive half percentage point increase in borrowing costs. As that decision ricocheted through markets around the world, the European Central Bank delivered a second blow by refusing to rule out an increase in rates this year as it too battles sky-high inflation.“Central banks have been wrong on inflation and now they are needing to play catch-up,” said Mark Dowding, chief investment officer at BlueBay Asset Management. “As they do that, financial markets don’t like what they are hearing.”Bond yields, which rise as prices fall, shot higher. The UK’s 10-year yield rose by 0.12 percentage points to 1.37 per cent, the highest level in more than three years. The equivalent German yield, a benchmark for assets across the euro area, climbed 0.11 percentage points to a nearly three-year high of 0.14 per cent.US government bonds were swept up in the selling, with the 10-year Treasury yield up 0.07 percentage points at 1.83 per cent, close to a recent two-year high.The BoE’s decision to raise interest rates by a quarter of a point to 0.5 per cent was broadly anticipated by markets, as the central bank tackles the highest UK inflation rate in 30 years. But the four votes for a bigger move on the BoE’s nine-strong rate-setting committee caught many investors off-guard. Traders cranked up their bets even more on a series of further rate increases to follow. Markets are now pricing in an increase to at least 1 per cent by May, and 1.5 per cent by November — compared with expectations of August and March next year prior to Thursday’s meeting.“It looks like rate hikes will be more front-loaded than the market was expecting,” said Howard Cunningham, a portfolio manager at Newton Investment Management.The BoE also said that it would begin the process of unwinding its debt purchases by not reinvesting the proceeds of maturing bonds it holds in its portfolio. The ECB’s decision to hold rates at a record low of minus 0.5 per cent was also in line with expectations. But markets were jolted by the ECB president’s departure from her previous insistence that 2022 rate increases were not consistent with the central bank’s guidance. Some analysts likened this to a shift in US monetary policy late last year, when the Federal Reserve dropped its long-held message that inflationary pressures were transitory.Markets now expect the ECB’s deposit rate to climb to minus 0.1 per cent by the end of the year.“President Lagarde in today’s press conference has clearly signalled a pivot” to a more active monetary policy and “turning the ECB into a live central bank”, said George Saravelos, Deutsche Bank’s global head of currency research.Riskier eurozone government debt was hit with an even bigger sell-off, pushing Italy’s 10-year bond yield up 0.23 percentage points to 1.64 per cent, the highest since May 2020. ECB policy has played a key role in narrowing the gap between yields in Germany and indebted eurozone members on the bloc’s “periphery”, typified by the promise Lagarde’s predecessor Mario Draghi made to do “whatever it takes” to save the euro.Salman Ahmed, global head of macro at Fidelity International, described Lagarde’s message at Thursday’s press conference as a “reverse Draghi moment”.“He called the shots and markets fell into line, while Lagarde is deciding not to push back on market pricing,” Ahmed said. More

Boris Johnson told the truth in the House of Commons this week. Three times on Monday and again three times on Wednesday, he said that the UK had the fastest growing economy in the G7. This is accurate. But prime ministers should be held, at least, to the same standards as accountants. Johnson’s comments did not remotely meet their basic metric that statements should be true and fair.Let’s do the truth bit first. Figures from the OECD show that in the third quarter of last year, the UK economy was 6.8 per cent larger than a year earlier, a higher rate of expansion than every other G7 nation. Moreover, both the latest OECD and IMF forecasts show the projected annual growth rate for 2022 to be top of the G7 league table. But to be true and fair, Johnson’s comments also need to be placed in a relevant context. In the first two quarters of 2020, the UK economy dived 21.6 per cent below its pre-pandemic level, significantly worse than any other G7 country. It is therefore not noteworthy that the recovery will also be quicker. Moreover, by the third quarter of last year, the UK was still second from the bottom of the G7 league table when comparing the overall recovery from Covid with pre-pandemic levels. Truth and fairness requires me to add that all of this data is being regularly revised, so we should not conclude that the UK recovery from coronavirus has been particularly poor. Given what we know about the fourth quarter of 2021, all we can say is that it has been similar to those in Germany, Italy, Canada and Japan, but slower than that in France and the US. If the prime minister was genuinely curious, he could ask smart officials to give him a rounded picture of the UK’s economic outlook. Last autumn, things were looking relatively bright, they would say. Households clearly wanted to see the back of the pandemic and were keen to spend. Businesses were successfully reopening as restrictions were lifted, boosting the capacity of the economy to supply goods and services. Unemployment stayed low, even as government support was reduced. And inflation was reported to be 2 per cent, although the Bank of England thought it would rise a little to peak at 4 per cent by Christmas. Almost everything we have subsequently learnt about the UK economy has been troubling. Although unemployment is low, evidence of a labour force problem is mounting, with 1mn fewer people either working or seeking work than we would have expected had the pandemic not occurred. That is roughly a 3 per cent hit to the available labour supply. As spending has increased, this has stoked inflation far more than almost anyone expected. It means the scope for catch-up growth is running out, now that unemployment is back at pre-pandemic levels. Worse, the UK growth rate is also artificially boosted by £25bn of corporate tax incentives this year and next, but investment remains weak. In the third quarter of 2021, it was still 4 per cent below pre-pandemic levels, lower than any other economy in the G7. UK exports have also not joined in the global boom. All this suggests that businesses are looking relatively unfavourably on this country, even before corporation tax rates rise from 19 per cent to 25 per cent in 2023. The IMF also reports good growth now will soon be followed by a slide to near stagnation in the pre-election year. It reckons the UK economy will end 2023 only 0.5 per cent larger than at the start, the lowest in the G7. So, if Johnson succeeds in hanging on as prime minister, a true and fair view shows an internationally mediocre UK economic recovery with a significant deterioration in prospect. It is enough to make a reasonable person think that remaining in Downing Street will not be much fun. [email protected] More

Official inflation in Turkey has reached the highest level since Recep Tayyip Erdogan’s ruling party came to power almost two decades ago, as global inflationary pressures combined with the president’s unorthodox economic management fuel a surge in prices. The country’s consumer price index rose 48.7 per cent year on year in January, the Turkish Statistical Institute said, up from 36 per cent in December.The figure, announced just days after Erdogan sacked the statistics agency’s head, was in line with the expectation of economists, according to a survey by Bloomberg — although opposition parties and some economists claimed it was far lower than the country’s true inflation rate.The reading was driven by sharp rises in the cost of food, electricity and gas, and represents the highest official rate that Turkey has experienced since April 2002. Erdogan, who was widely credited during his first decade in power with ushering in economic prosperity, has presided over repeated bouts of high inflation in recent years as he has consolidated his powers and meddled in monetary policy. The Turkish president, an ideological opponent of high interest rates, ordered the central bank to cut borrowing costs four times in a row last year, bringing the policy rate to 14 per cent despite warnings that it would exacerbate the country’s already high inflation.Erdogan has long argued, contrary to established economic orthodoxy, that lowering rates helps to stabilise prices. But economists say that the plunge in the lira that often accompanies the rate cuts quickly feeds through into rising prices in a country that is heavily reliant on imported energy and goods. The Turkish currency lost 44 per cent of its value against the dollar in 2021.Turkey’s recent rate-cutting drive also puts it at odds with global central banks that are tightening policy in a bid to cool the highest rate of inflation in decades. Polls suggest that support for Erdogan’s AKP is close to historic lows amid public discontent about the soaring cost of living.Still, Turkey’s finance minister, Nureddin Nebati, said prior to Thursday’s announcement that there would be “no turning back” from the policy of having interest rates that are far below inflation. “We have no rate hike in our agenda,” he told Nikkei Asia. Nebati said that he expected inflation to peak at a level below 50 per cent in April.Goldman Sachs, the US investment bank, predicted that inflation would rise to around 56 per cent in May and remain close to that level for much of the year. “With real rates deeply in the negative territory, we also think that the policy stance adds to the inflationary risks,” it said. More

The big news from today’s Bank of England decision is that four of the Monetary Policy Committee’s nine members wanted a bigger rise in interest rates than the 25 basis-point rise that occurred. Michael Saunders, Dave Ramsden, Jonathan Haskel and Catherine Mann all called for a 50 basis-point rise to 0.75 per cent. Dissent in this scale is unusual, so it’s unsurprising that sterling has soared on the back of the news. But, having skimmed the minutes of the vote, we’re wondering why the four didn’t call for an even bigger rise. Here’s the write-up on why they plumped for 50 basis points: (our emphasis)Four members judged that a 0.5 percentage point increase in Bank Rate was warranted at this meeting. Monetary policy had been very accommodative, and capacity pressures were now widespread, especially in the labour market. The projected path for CPI inflation was again being revised up over the first two years of the forecast period, while medium-term inflation expectations remained relatively high and on some measures had increased further. Companies responding to the Decision Maker Panel had indicated that they expected to raise prices significantly in 2022. The strong pick-up in pay settlements reported to the Bank’s Agents, and the recent broadening from goods price to services price inflation, suggested that these developments were now being reflected in domestic costs and prices, which could make CPI inflation more persistent than was expected in the February Report central projection. Monetary policy should tighten to a greater extent at this meeting in order to reduce the risk that recent trends in pay growth and inflation expectations became more firmly embedded and thereby help to bring inflation back to the target sustainably in the medium term.Inflation is, according to the Bank, going to hit 7 per cent this year. If these four monetary policymakers really do think there’s a risk that prices keep rising at that pace for the foreseeable future, shouldn’t bank rate be an awful lot higher than 0.75 per cent? One could argue that the Bank’s policymakers want to be seen as consistent in their communication. A 50 basis-point rise would have surprised investors, for sure. Yet shock-and-awe cuts of far more than 50 basis points did occur during the early days of the financial crisis. Rates were also cut by 50 basis points in March 2020. On the flipside, if the other five members don’t think it’s the case that high inflation will become entrenched, then why are they backing a rate hike at all? People in the UK have just been told that their energy bills are going to rise by more than 50 per cent. For those with a flexible rate mortgage, the Bank’s hike will only add to the squeeze on their disposable incomes. Less disposable income means lower demand — a situation that’s supposed to be addressed by, err, lower rates. The Bank’s decision, by boosting sterling, will mitigate the impact of the rise of imported prices. But the main reason behind the move seems to be the view that, by raising rates, the Bank might influence expectations of future inflation. We’re far from convinced that’s the case. Andrew Bailey emphasised today that the inflation we’ve had is due to a “terms of trade” shock, and that the price rises we’ve seen of late were not the sort that are in the gift of the Bank to control. That may be right. Threadneedle Street has little say on global shipping rates or the cost of natural gas. But, if there’s war in Ukraine and energy prices rise further, we fail to see how rate hikes by the Bank will do any good in stemming calls for higher wages. We think calls for better pay are far more of a function of the cost of living than they are the Bank’s inflation goal. The fuzzy logic behind today’s decision says a lot about a more fundamental flaw of inflation targeting. When the framework was devised, it was assumed that, in a globalised world, any terms of trade shocks would be short lived and need not concern policymakers focused on what will happen to prices in the years ahead. The pandemic has shown that is not a safe assumption to make. The merits of the regime were oversold. And now we’re all paying for it. More