The latest mini-budget from the UK sent gilt markets into a sharp fall and the GBP had its own mini crash. Why should fiscal stimulus be seen as so negative for the UK? The bottom line was that investors feared that the huge stimulus package would only end up fuelling inflation and actually making the eventual pullback in the UK economy worse. Rising debt levels to fuel an economy struggling with inflation was ultimately seen as a very poor fiscal decision.
What can the BoE do?
The expectations are that the Bank of England will now need to hike interest rates more aggressively. STIR market pricing shows a terminal rate just shy of 6%. This is up from 4.63% only a week ago. 125 bps of rate hikes are now expected for the November meeting.
What else can the BoE do? Nothing can be the best policy.
The BoE can use some of its FX reserves to buy the GBP if there is more of a disorderly move in the GBP or the gilt market. Aside from that the Bank of England’s response to the flash crash early on September 26 is probably the best blueprint. Just wait. The BoE pushed the market to wait on Monday 26th September to the next monetary policy meeting. BoE’s Chief Economist Pill did the same on Tuesday 27 September when he addressed markets.
So, in balance, the less the BoE does now the better. A great deal of the GBP’s weakness is due to USD strength, so any weakness in the USD over the coming weeks could end up helping the BoE’s cause. Also, by keeping market actions to expected times it should, at this stage, keep the BoE’s credibility that it can handle the GBP even if the Gov’t fiscal policy is potentially inflation-inducing.