FTSE, pound and bonds undermined on UK financial stability concerns

If you want to know whether the Bank of England’s latest intervention to fix the UK’s rising borrowing costs is working or whether investors have the confidence that the government knows what it is doing, just look no further than a simple chart of the FTSE, GBP/USD or UK bonds. They are all pointing lower. Hint: that is not good. The FTSE could revisit its March low soon.

Inflation is soaring and borrowing costs are rising. Sometimes spending your way out of trouble is going to cause an even bigger problem down the line. And that is precisely what the markets are worried about.

Investors fear that the UK government is borrowing too much and that it won’t be able to balance its books. Indeed, economists argue that instead of spending, the government should be concentrating on cuts. The economy will not be strong enough to generate the extra tax revenue the government hopes it will get to plug in the deficit. In fact, the Institute for Fiscal Studies (IFS) has found that the UK government will need to spend £60bn less per year by 2026-27 in order to put the country’s finances on a sustainable path.

Unless something changes fundamentally to boost investor confidence in the UK, investors’ required rate of return (i.e., yields) on the bonds they hold from the UK government will continue to rise. Which is why bond prices have been falling (as yields move inversely with bond prices). So, the BoE is stepping in to try and fix the problem by buying government bonds, in order to depress yields. Today the Bank again warned of a risk to the UK's financial stability, as it stepped in again to buy more government debt and stabilise markets amid rising concerns about pension funds.

The BoE's latest intervention to stem a collapse in the bond market involves purchasing inflation-linked debt until the end of the week. This is "a further backstop to restore orderly market conditions," says the Bank. The rewed warning and latest intervention goes to show how concerned the central bank is about the risk to UK's financial stability.

But despite its latest efforts, markets are uncertain over how the BoE will achieve an "orderly end" to its emergency bond buying scheme this week. Traders might wait for the BoE to step aside, and then punish bonds – and the pound – once again. I reckon the BoE needed to keep the bond buying programme a bit longer, and without pre-committing to a specific end date, for the plan to have worked better. It could be that they will realise they made a mistake and re-assess the situation again later this week.

But for now, their efforts are not working as well as they had hoped. As yields on government debt remain near pre-intervention levels, investors have continued to sell the pound and UK stocks, although the latter is also affected by investor dislike of holding equities on a global scale.

As a result of the above macro concerns, and the stock market’s continued bearish price action, the FTSE could revisit its March low of 6762 soon.

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