Home Business Financial Repression May Become Necessary to Contain UK Yields

Financial Repression May Become Necessary to Contain UK Yields

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(Bloomberg) — The sharp rise in gilt yields and fall in sterling after today’s mini-budget may force the UK government to direct domestic savers and banks to own more government debt.

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It’s not overly alarmist to say the UK is in some trouble – especially with the pound falling more than 3% against the dollar so far today. Already trying to finance one of the world’s largest twin (budget + current) deficits, while growth is in structural decline and inflation is surging, the UK has to contend with its new government today announcing a fiscal package that will massively ramp up spending through a combination of energy subsidies and tax cuts.

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UK bonds and sterling are selling off rapidly as a result. The Bank of England is in an emerging market-style dilemma as it needs to continue raising rates to keep a lid on inflation. More aggressive hikes will eviscerate growth, further deterring the capital inflow necessary to balance the UK’s vast external deficit.

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The UK may thus be forced to try to stabilize yields. More quantitative easing is a risky option as this would counter the BoE’s inflation fight and send very mixed signals to the market. Ditto for some sort of yield-curve control. Such a policy is more viable when you don’t have a huge current-account deficit and inflation nudging 10%. Either policy would probably result in sterling going into an even greater free-fall.

Instead, the government can direct UK entities to channel private-sector flows into the public debt market – a type of financial repression – allowing the government to borrow at below-market rates. 

This would lead to sharp selloffs in equities, as private flows are directed toward bonds, triggering yet more capital outflow and a weaker currency. Investment would be in jeopardy due to crowding out, further imperiling already-stagnant UK productivity. Overall, history shows that financial repression regresses the development of the economic system.

But the UK is running out of options. Its economic model of a commodity-dependent, export-orientated country, reliant on large capital inflows, doesn’t work in a resource-constrained, de-globalizing world economy. The luxury of palatable choices is one the UK can no longer enjoy.

  • NOTE: Simon White is a macro strategist for Bloomberg’s Markets Live blog. The observations he makes are his own and are not intended as investment advice. For more markets commentary see the MLIV blog


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