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Column: BoE hike would expose Treasury/Central Bank tangle

By Mike Dolan

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Column: BoE hike would expose Treasury/Central Bank tangle
© Reuters. People walk past the Bank of England in London, Britain, October 22, 2021. REUTERS/Tom Nicholson

By Mike Dolan

LONDON (Reuters) – With markets primed for a Bank of England interest rate rise as soon as next week, UK policymakers now start to face an uncomfortable entanglement of monetary and fiscal policy bequeathed by central bank bond buying, or ‘quantitative easing’.

Wednesday sees UK finance minister Rishi Sunak lay out his latest government budget, likely relieved by lower borrowing estimates than initially forecast after the pandemic hit but also under pressure to outline a framework for stabilising public finances medium term.

However, the BoE’s rhetorical twist over the past month has guided money markets to expect a rise in its historically low 0.1% policy rate by yearend as inflation expectations build. And it now exposes a long-running debate about how vulnerable UK government debt is to higher rates.

The Office for Budget Responsibility – the British government’s own budget watchdog – has flagged the problem all year and stresses the pressure higher interest rates present the government’s vast debt pile – which at 100% of national output is three times levels 20 years ago.

And the financial exposure to Treasury of higher short-term interest rates raises worries for many observers about central bank autonomy and the willingness to tackle inflation should it become a problem. The BoE only gained operational independence from government as recently as 1997 but still reports to the Treasury, which also dictates its inflation target.

In essence, the problem involves the maturity mismatch due to years of on-off QE programmes that have lifted the BoE’s balance sheet since the 2008 banking crash and again since the pandemic – mainly to keep a lid on long-term borrowing costs.

QE involves the purchase of mostly gilts from commercial banks in return for interest-bearing reserves at the central bank rather than cash per se. And the floating interest rate on those bank reserves is the ‘Bank Rate’ the BoE uses to adjust its overall monetary policy.

Raising short-term interest rates with a trillion dollar balance sheet has its problems for central bank and government alike.

As interest rates tumble, it was win-win. Not only are debt servicing costs capped, but there’s a major windfall for the central bank as it pays out a lower interest rate on bank reserves than it receives on the longer-term debts on its balance sheet. And it sent those profits back to the Treasury.

Earlier this year, the OBR estimated that to date the positive cash flow alone from the Bank of England’s so-called Asset Purchase Facility to the Treasury totalled 113 billion pounds ($156 billion)

But all that gets turned on its head when the Bank Rate starts to rise – most likely faster than long-term rates – and especially if the yield curve were to invert. The Treasury indemnifies all BoE losses.

UPSIDE DOWN

The OBR estimates that almost a third of gross government debt – or 875 billion pounds ($1.2 trillion) – will be held in the form of bank reserves by the end of next year. Market pricing already has the Bank Rate nine times higher than it is today – a rise to about 90 basis points from 0.1%.

The cost of a one percentage point rise in interest rates across the spectrum on consolidated public sector liabilities would be as much as half a percent of GDP within 12 months.

Another implication is that instead of outstanding gilts having the longest median maturity of the G7 at more than 14 years, the consolidated public debts have a median maturity of just 2 years – dangerous in any period of protracted interest rate rises.

According to the OBR, this new scenario – along with the fact that about a quarter of UK government debt is now inflation protected – also means a burst of inflation no longer has the positive effect on debt ratios that it had several decades ago.

In an article published by VoxEU this week, economists Charles Goodhart and Manoj Pradhan – authors of a 2020 book arguing a structural revival of global inflation was underway – reckon central banks need to be careful about sudden and destabilising policy reversals to restore credibility even if inflation persists.

But they warn the persistence of large central bank balance sheets in a period of rising interest rates raises all sorts of political questions about paying commercial banks larger and larger returns on reserves and also about how much Bank policy costs Treasury directly.

“At a time of worsening debt service ratios, the need for increased taxation and the transfer of increasingly large payments from the public purse to commercial banks for holding reserves at the central bank will become increasingly politically unpopular,” they wrote. “You do not have to be a populist politician to see how this conjuncture could become … difficult to defend.”

“Central banks will have to bear capital losses on their holdings and could need recapitalisation from governments,” Goodhart and Pradhan added. “That process will have to be structured in a way that does not raise questions about central bank independence.”

There are some offering solutions. Economists at the independent UK think tank the National Institute of Economic and Social Research in July said Treasury and central bank should reduce the maturity mismatch by swapping longer-dated gilts back to Treasury to reduce the duration of its portfolios.

“Our proposal aims to limit even the appearance of conflicts between the Treasury and the central bank when macroeconomic policies have to tighten,” they wrote.

(by Mike Dolan, Twitter (NYSE:): @reutersMikeD)

Economy

Treasury’s Yellen: Biden stimulus at most a ‘small contributor’ to inflation

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Treasury's Yellen: Biden stimulus at most a 'small contributor' to inflation
© Reuters. FILE PHOTO: reasury Secretary Janet Yellen pauses while testifying before a Senate Banking Committee hybrid hearing on oversight of the Treasury Department and the Federal Reserve on Capitol Hill in Washington, U.S., November 30, 2021. REUTERS/Elizabeth F

By Andrea Shalal and David Lawder

WASHINGTON (Reuters) – U.S. President Joe Biden’s $1.9 trillion stimulus package in March contributed to stronger demand but is only a small factor in current higher rates of inflation, U.S. Treasury Secretary Janet Yellen told lawmakers on Wednesday.

Yellen told the House Financial Services Committee that the stimulus package clearly boosted demand but said it was not a “fair assumption” to say it overshot the need and fueled current spikes in inflation.

“It’s certainly true that the American Rescue Plan put money in people’s pockets … and contributed to strong demand in the U.S. economy, but if you look at the amount of inflation that we have, and its causes, that is at most a small contributor,” she said.

High inflation, now running at more than twice the Federal Reserve’s flexible target of 2% annually, is expected to ease in the second half of 2022, Fed Chair Jerome Powell told lawmakers at Wednesday’s hearing.

Yellen, grilled by Republican lawmakers about the inflationary impact of Biden’s response, insisted there was a “very good reason” to proceed with the stimulus package to deal with a shortage of demand that could have resulted in long-lasting joblessness and high unemployment.

“It’s been successful,” she said. “It did boost demand, and that is one of several factors that are involved in inflation.”

Yellen said the main driver of inflation was the COVID-19 pandemic and its impact in diverting demand away from services and “massively” toward goods, resulting in supply chain problems as well as a lasting effect on labor supply.

She said the pandemic had delivered an “unusual shock” to the workforce, and concerns about health issues were keeping many low-income workers from returning to their jobs, but that should recede as the pandemic was brought under control.

Biden’s plan for $1.75 trillion in further social and climate spending over the next decade was a small amount relative to the size of the U.S. economy, was paid for, and would lead to improvements that lowered deficits, Yellen said.

“It puts in place investments that will continue to bring down deficits,” she said. “It will improve the supply side of the economy, which is, in the long run, a factor that will tend to mitigate ongoing inflationary pressures.”

Yellen sparred for a second day with Republican lawmakers who cited a Congressional Budget Office estimate the “Build Back Better” legislation would add $367 billion to U.S. deficits over a decade.

She stuck to her argument that the CBO estimate does not include the effects of increased Internal Revenue Service enforcement, which the Biden administration has estimated would boost revenues by $400 billion over a decade.

Disclaimer: Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. All CFDs (stocks, indexes, futures) and Forex prices are not provided by exchanges but rather by market makers, and so prices may not be accurate and may differ from the actual market price, meaning prices are indicative and not appropriate for trading purposes. Therefore Fusion Media doesn`t bear any responsibility for any trading losses you might incur as a result of using this data.

Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.

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Economy

Some Republicans in U.S. Congress try to close government over vaccine mandates

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Some Republicans in U.S. Congress try to close government over vaccine mandates
© Reuters. FILE PHOTO: The U.S. Capitol building is seen in Washington, U.S., November 16, 2021. REUTERS/Elizabeth Frantz/File Photo

By Susan Cornwell and David Morgan

WASHINGTON (Reuters) – U.S. lawmakers’ efforts to keep the U.S. government operating hit a stumbling block on Wednesday as a group of hard-line Republicans threatened to try to block any plan that allowed COVID-19 vaccine mandates to proceed.

Congress has until midnight on Friday to pass a measure continuing to fund federal government operations or face a partial shutdown during a pandemic that would be a political embarrassment to President Joe Biden’s Democrats, who narrowly control both chambers of Congress.

The hard-line Republican House Freedom Caucus called on Senate colleagues on Wednesday to vote against any measure, known as a “continuing resolution,” that would support Biden’s requirements that workers at federal contractors and large companies receive the COVID-19 vaccine.

“Use all procedural tools at your disposal to deny timely passage of the CR unless it prohibits funding – in all respects – for the vaccine mandates and enforcement thereof,” the group wrote in an open letter to top Senate Republican Mitch McConnell.

McConnell earlier in the week said he was confident that the measure funding the government would pass. House Republicans do not have enough votes to block legislation. But most legislation requires 60 votes to advance in the evenly divided 100-seat Senate, so Democrats would need support from at least 10 Senate Republicans to get to a vote on passage.

Democratic Senate Majority Leader Chuck Schumer told reporters talks with McConnell on funding the government were “making good progress”. He dismissed the Freedom Caucus’ threat.

“We’ll have total chaos,” Schumer said. “It’s up to the leaders on both sides to make sure that doesn’t happen.” Other lawmakers suggested one way to solve the problem would be to allow a separate vote on the vaccine mandates.

Negotiations between the two parties are focused on how long to continue to fund the government. Democrats want to extend current funding levels just until January and then pass new spending bills, while Republicans have urged a delay until later in the spring, a move that would leave spending at levels agreed to when Republican Donald Trump was president.

The Biden administration was blocked in court on Tuesday from enforcing two mandates requiring millions of American workers to get vaccinated against COVID-19, a key part of its strategy for controlling the spread of the coronavirus.

One federal judge temporarily blocked enforcement of a government mandate for healthcare workers. Another blocked the administration from enforcing a regulation that new government contracts must include clauses requiring that contractors’ employees get vaccinated.Democrats were indignant at the conservative Republicans’ demand. “I think we’re in the middle of a public-health crisis. And vaccine requirements are reasonable public-health measures at this particular point in time,” House Democratic Caucus Chairman Hakeem Jeffries told reporters.

Disclaimer: Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. All CFDs (stocks, indexes, futures) and Forex prices are not provided by exchanges but rather by market makers, and so prices may not be accurate and may differ from the actual market price, meaning prices are indicative and not appropriate for trading purposes. Therefore Fusion Media doesn`t bear any responsibility for any trading losses you might incur as a result of using this data.

Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.

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Economy

Powell says Fed policy must address range of plausible outcomes

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Powell says Fed policy must address range of plausible outcomes
© Reuters. FILE PHOTO: Federal Reserve Chair Jerome Powell prepares to testify before a Senate Banking Committee hybrid hearing on oversight of the Treasury Department and the Federal Reserve on Capitol Hill in Washington, U.S., November 30, 2021. REUTERS/Elizabeth

By Jonnelle Marte and Lindsay (NYSE:) Dunsmuir

NEW YORK (Reuters) -With the U.S. economy growing strongly and supply-demand imbalances poised to persist in the near future, policymakers need to be ready to respond to the possibility that inflation may not recede in the second half of next year as expected, Federal Reserve Chair Jerome Powell said on Wednesday.

Powell, in his second day of testimony https://www.reuters.com/markets/us/powell-yellen-head-congress-inflation-variant-risks-rise-2021-11-30 in Congress, said policy will need to adapt as officials seek to bring millions of Americans back to work while also ensuring that the recent surge in inflation does not become entrenched.

“Almost all forecasters do expect that inflation will be coming down meaningfully in the second half of next year,” Powell said in a hearing before the U.S. House of Representatives Financial Services Committee. “The point is, we can’t act as though we are sure of that … We have to use our policy to address the range of plausible outcomes, not just the most likely one.”

Powell said the U.S. recovery is stronger than those of other major economies, thanks in part to more robust fiscal support. U.S. consumer spending surged in October and first-time applications for unemployment benefits are at a 52-year low, leading economists to raise their GDP growth estimates for the fourth quarter.

Still, consumer confidence dropped https://www.reuters.com/markets/us/us-consumer-confidence-ebbs-november-2021-11-30 to a nine-month low in November amid worries about the rising cost of living and pandemic fatigue. The new Omicron variant of COVID-19 is also creating more uncertainty for households and businesses.

Powell said Fed officials are monitoring the evolving economic landscape and acknowledged they might face “tension” as they pursue their dual mandate of achieving maximum employment and price stability.

“We have to balance those two goals when they are in tension, as they are right now,” Powell said. “But I assure you we will use our tools to make sure that this high inflation we are experiencing does not become entrenched.”

While wages are rising, particularly for low-wage workers, the increases are not happening at a pace that could spark higher inflation, the U.S. central bank chief said.

“We have seen wages moving up significantly,” Powell said. “We don’t see them moving up at a troubling rate that would tend to spark higher inflation, but that’s something we’re watching very carefully.”

On Tuesday, Powell told the U.S. Senate Banking Committee that Fed policymakers would discuss at their Dec. 14-15 meeting whether to end their bond-buying program a few months earlier than had been anticipated.

Last month, the Fed began reducing its purchases of Treasuries and mortgage-backed securities from $120 billion per month at a pace that would put it on track to complete the wind-down by mid-2022. The program was introduced in early 2020 to help nurse the economy through the pandemic.

Disclaimer: Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. All CFDs (stocks, indexes, futures) and Forex prices are not provided by exchanges but rather by market makers, and so prices may not be accurate and may differ from the actual market price, meaning prices are indicative and not appropriate for trading purposes. Therefore Fusion Media doesn`t bear any responsibility for any trading losses you might incur as a result of using this data.

Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.

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