UK hit hard by bond blunder
How headroom of £30bn in the UK’s public finances became a black hole of £70bn to be filled in this week’s Budget appears to be one of life’s mysteries. Those looking for political scapegoats blame Liz Truss and Kwasi Kwarteng and their swashbuckling approach to tax cuts and borrowing.
That played a large part in the determination of Chancellor Jeremy Hunt to revert to fiscal orthodoxy amid concerns about fresh assaults on the pound and gilt-edged stock.
The real villain of the piece is inflation. It impacts by increasing the cost of government – notably welfare bills – and, as significantly, raises the price of servicing the national debt. Faced with elevated borrowing requirements post the financial crisis and Covid-19, the UK went all out on using index-linked debt to fund borrowing.
This made the work of the Debt Management office much easier because of a voracious appetite from pension fund managers, because it assisted in balancing assets with liabilities. The returns on index-linked gilts kept pace with the inflation triggers in the trust deeds of many funds.
It can now be seen how misguided this policy has proved and why the Government’s
interest rate bill has become such a critical element in Treasury thinking. High dependence on index-linked gilts has proved a burden on the Exchequer.
It was assumed that the Bank of England would be so good at its job of meeting the inflation target of 2pc that the downside risk of issuing these gilts was minimal.
Another kink is that inflation-linked gilts have moved with the retail prices index (RPI), which generally runs hotter than the consumer price index (CPI).
The upshot is that at least half of the £70bn upsurge in borrowing costs can be traced to index linked gilts.
At 23.9pc of the UK’s total debt issue, the UK has the highest proportion of indexlinked among G7 countries and twice as much as the next nearest borrower. This means that the UK is a total outlier in its dependence on index-linked stock.
The danger of inflation getting out of hand never appears to have occurred to successive chancellors, who signed off on debt issuance, or the Treasury and Debt Management office, which advises government.
Last week, the Bank of England’s chief economist Huw Pill acknowledged that quantitative easing is partly responsible for runaway inflation of 10.1pc. The Bank cannot escape its own responsibility for a funding fiasco by the Government that every citizen will pay for through higher taxes.
Fringe finance
THE FTX fandango provides insight into how the rise of non-bank banking, or unregulated finance, provides a clear and present danger to stability.
At least when liquidity-driven investments imploded after the mini-Budget, the Bank of England, fearing a cascade of insolvencies which could spread to the banking system, was there with a safety net.
Britain’s 10m members of defined salary pensioners were protected. This was no thanks to the Pensions Regulator, which is meant to insulate retirees from risk.
No such safety nets exists in the bizarre universes of crypto-currencies and its close cousin, non-fungible tokens (NFTs). Latest data from inside FTX shows that the bankrupt crypto exchange had just $900m of easily accessible assets last week against $9bn of liabilities. No one quite knows where the losses will land, but if recent blow-ups – such as those at invoice-finance house Greensill and hedge fund Archegos – are a guide, there could easily be leakage into mainstream banking.
All this reminds us why regulators need to get a grip in the newbies in the industry. Klarna boss Sebastian Siemiatkowski describes the FTX blow-up as ‘fairly scary’ but cautions against over-regulating fintech players, arguing ‘we need more competition in banking’. In principle he is right. But one couldn’t blame consumers and businesses that have embraced new models for putting their trust in established, regulated methods in an era of rising interest rates and a slowing global economy.
Image makers
THE failure of Joules will have aspirational fans of the faux preppie, country-style fashion brand shedding tears into their muesli from Muswell Hill in London to Lake windermere. But do not fear. Good, strong brands still have universal appeal as recognised by Next when it bought Made.com, M&S which rescued Jaeger and Frasers now in pursuit of Savile Row’s Gieves & Hawkes.