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Britain hard hit by bond blunder: Bank of England must accept responsibility for a mistake we will all eventually pay for, says ALEX BRUMMER
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How a £30bn gap in Britain’s public finances became a £70bn black hole to fill in this week’s budget seems to be one of life’s mysteries.
Those looking for political scapegoats blame Liz Truss and Kwasi Kwarteng and their fearless approach to tax cuts and borrowing.
That played a big part in Chancellor Jeremy Hunt’s determination to return to fiscal orthodoxy amid concerns about new attacks on the pound and gilt-edged equities.
Bad decision: Last week, Bank of England chief economist Huw Pill (pictured) acknowledged that quantitative easing contributed to the runaway 10.1% inflation
The real villain of the play is inflation. It affects by increasing the costs of government – particularly social bills – and, equally significantly, raises the price of servicing the national debt. Faced with increased funding requirements following the financial crisis and Covid-19, the UK went all out in using indexed debt to fund loans.
This made the job of the Debt Management Office much easier due to a voracious appetite of pension fund managers as it helped balance assets and liabilities.
Returns on indexed gilts have kept pace with inflation triggers in many funds’ trust deeds.
It is now clear how misleading this policy has proven and why the government’s interest bill has become such a crucial element in Treasury thinking. The heavy reliance on indexed gilts has proven to be a burden on the Treasury.
It was assumed that the Bank of England would be so good at meeting its inflation target of 2% that the downside risk of issuing these gilts was minimal.
Another kink is that inflation-linked gilts have moved along with the retail price index (RPI), which is generally hotter than the consumer price index (CPI).
As a result, at least half of the £70 billion increase in borrowing costs can be traced to index-linked gilts.
With 23.9 per cent of the UK’s total debt issuance, the UK has the highest rate of inflation-linked loans of the G7 countries and twice as much as the next borrower. This means the UK is a total outlier in its reliance on index-linked equities.
The danger of inflation spiraling out of control never seems to have occurred to successive chancellors, who signed the debt issuance, or to the Treasury and Debt Management Office, which advises the government.
Last week, Bank of England chief economist Huw Pill acknowledged that quantitative easing contributed to the runaway 10.1 percent inflation.
The Bank cannot escape its own responsibility for a government funding fiasco that every citizen will pay for through higher taxes.
Edge financing
The FTX fandango provides insight into how the rise of nonbank banking, or unregulated financing, poses a clear and current threat to stability.
When liquidity-driven investment imploded after the mini budget, the Bank of England, fearing a cascade of insolvencies that could spread to the banking system, was at least there with a safety net.
Britain’s 10 million fixed salary pensioners were protected. This was not due to the Pension Supervisor, which is intended to protect pensioners against risks.
No such safety nets exist in the bizarre universes of crypto-currencies and its close cousin, non-fungible tokens (NFTs). The latest data from FTX shows that the bankrupt crypto exchange had just $900 million in easily accessible assets against $9 billion in liabilities last week.
No one knows exactly where the losses will end up, but if recent blowouts — such as those at bill financing house Greensill and hedge fund Archegos — are any guide, there could easily be leaks to mainstream banking.
All this reminds us why regulators need to get a handle on the industry’s new entrants. Klarna boss Sebastian Siemiatkowski describes the FTX blowout as “quite scary,” but warns against over-regulating fintech players, arguing “we need more competition in banking.”
In principle he is right. But consumers and businesses that have embraced new models cannot be blamed for relying on established, regulated methods in an era of rising interest rates and a slowing global economy.
image makers
The failure of Joules will have aspiring fans of the faux preppie, country fashion brand shed tears in their muesli, from London’s Muswell Hill to Lake Windermere.
But don’t be afraid. Good, strong brands still have universal appeal, as recognized by Next when it bought Made.com, M&S that rescued Jaeger and Frasers, now chasing Savile Row’s Gieves & Hawkes.
Reincarnation awaits.