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British debt soars and approaches the levels of the crisis unleashed by Truss

2023-05-26T10:49:44.087Z

Highlights: The UK Treasury bond market is once again experiencing hectic hours, reminiscent of the panic caused last September by the tax cut of the ill-fated former Prime Minister Liz Truss. At 8.7% in April, the figure was notably lower than the 10.1% recorded in March, but much higher than many analysts had expected. Investors now estimate that the BoE will have to continue raising interest rates, currently at 4.5%, to exceed 5% before 2024. The interest rate on a ten-year British government bond is now 4.4%.


Persistent inflation causes nervousness in the markets, reminiscent of the crisis unleashed by the former prime minister's tax cut


The UK Treasury bond market is once again experiencing hectic hours, reminiscent of the panic caused last September by the tax cut of the ill-fated former Prime Minister Liz Truss. The yield of the so-called gilts – public debt bonds – has rebounded after knowing, last Wednesday, the new inflation data of the country. At 8.7% in April, the figure was notably lower than the 10.1% recorded in March, but much higher than many analysts had expected.

The Bank of England (BoE) has already decided to change its mathematical model, after successive failed forecasts in which it indicated that prices would fall in the United Kingdom faster than they are doing. "There are important lessons to be learned," acknowledged the governor of the monetary authority, Andrew Bailey, on Tuesday before a committee of the British Parliament, after admitting the failure of the institution, which had anticipated an inflationary figure of 8.4% for the month of March.

Prime Minister Rishi Sunak himself has been caught up in his promise to halve inflation before the end of the year. Investors now estimate that the BoE will have to continue raising interest rates, currently at 4.5%, to exceed 5% before 2024.

The markets' response began on Wednesday, but intensified on Thursday. Two-year government bonds have seen their yield rise as much as 17 basis points in a matter of hours. Throughout the week, the increase has reached 60 points. During the crisis generated by the mini-budget – basically, a massive tax cut – of the tandem Liz Truss-Kwasi Kwarteng (the former Minister of Economy) the increase reached 89 basis points. That level of crisis has not yet been reached, but it has reached a level similar to that of the market crisis in 2008 and 2009.

As the yield increases, the value of the bond decreases. Investors anticipate that, with more expensive money, new debt issues will be more profitable, forcing them to reduce the value of outstanding bonds to match that yield.

Government debt, therefore, is higher, and investors who accumulate public debt lose value. The interest rate on a ten-year British government bond is now 4.4%, much higher than Germany's 2.5% or France's 3%, and only comparable to Italy's 4.3%.

"There are lingering fears about the possibility of runaway inflation in the UK, and there are concerns about the BoE's supposed ability to deal with this problem," said Joel Kruger, market strategist at LMAX Group. The collapse of bonds and the pound sterling last September provoked the drastic intervention of the BoE, which launched to buy debt and warned, in the style of Mario Draghi's historical whatever it takes, that it would act as many times as necessary to stabilize the markets.

Since then, the new government of Rishi Sunak and his Chancellor of the Exchequer, Jeremy Hunt, has raised taxes and cut public spending. They have managed to convey calm and credibility to the markets, accompanied also by an improvement in relations between London and Brussels, and the beginning of a solution to the constant dispute over Northern Ireland's fit in the post-Brexit era.

The current situation, investors say, points to an adjustment also quite drastic but presumably more orderly. "The markets are still calibrating what the BoE will finally do, and they are still doubtful. It will take a while for them to digest this latest tremor," warns the senior manager of global investment fund Newton Investment Management. The key, in the coming months, will lie in the evolution of inflation – especially core inflation, which excludes food and energy – which, in the United Kingdom, is reluctant to fall. The IMF has modified its growth forecast for this country in 2023 and no longer predicts a recession, but the rise points to a scant 0.4%.

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Source: elparis

All business articles on 2023-05-26

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