The Bank of England is in danger of losing the currency war

by Shaun Richards

Over the weekend the Bank of England found itself being left behind by events. Perhaps it took the concept of the late summer Bank Holiday too seriously as whilst Governor Andrew Bailey was present at Jackson Hole and presumably enjoyed the hospitality he said nothing of note and thus did not respond to this.

The other path is one of determination. On this path, monetary policy responds more forcefully to the current bout of inflation, even at the risk of lower growth and higher unemployment. This is the “robust control” approach to monetary policy that minimises the risks of very bad economic outcomes in the future.

Three broad observations speak in favour of central banks choosing the latter path: the uncertainty about the persistence of inflation, the threats to central bank credibility and the potential costs of acting too late.

In many ways this was an extraordinary speech from Isabel Schnabel of the ECB who spent quite some time dismissing the inflation surge as we note “Transitory” has morphed into “uncertainty” about the “persistence” of inflation. However we have 3 markers for the Bank of England from it. Then there was more.

Policymakers should also not pause at the first sign of a potential turn in inflationary pressures, such as an easing of supply chain disruptions. Rather, they need to signal their strong determination to bring inflation back to target quickly.

Then she suggested a policy response.

Both the likelihood and the cost of current high inflation becoming entrenched in expectations are uncomfortably high. In this environment, central banks need to act forcefully.

Now let me switch to what all this means and I will do so from the perspective of Frederik Ducrozet because he is about as much an ECB insider as you can be whilst working elsewhere.

@Isabel_Schnabel‘s speech in Jackson Hole is as powerful as Powell’s, only more documented. A strong case for determination over caution, for the ECB to act forcefully as high inflation risks becoming entrenched. It’s possible that she calls for a 75bp hike in September.

The takeaway from this is simply that the ECB is now expected to raise interest-rates by 0.75% next time around. A response to this was the German two-year yield rising over 1% yesterday.

If we switch now to the Bank of England it was caught asleep by the development and is left in a world where it thinks a 0.5% increase in interest-rates is a big deal or bazooka. I have previously called it a “peashooter” and with the US Fed having raised by 0.75% and the Bank of Canada by 1% and now the ECB is floating the idea of it raising by 0.75% it looks even more so.


The UK Pound £

Regular readers will be aware that I have long argued that we should set policy to support the UK Pound as it is anti-inflationary. Actually that has taken a further nuance this year because with the US Dollar being so strong it has been a type of competition between central banks as to how they respond to this. As an example this is why I argued some time ago that the Bank of Canada would copy US interest-rate moves which they have tried to do in spite of their meetings being before the US.

Thus over the weekend the Bank of England was caught out by the hawkish shift meaning we fell below US $1.17 versus the US Dollar. We also moved through 0.85 versus the Euro. So in the new era where a facet of monetary policy is via your exchange rate they were caught napping.

UK Bond Yields

This is another area where the moves at the moment are usually international. In response to the central banking rhetoric which was reinforced at Jackson Hole we see higher bond yields. So we have a two-year yield of 2.94% now as markets look to price in the rhetoric. It has also got Reuters excited.

LONDON, Aug 30 (Reuters) – British government bonds are on course for their biggest monthly fall since 1994, as surging energy prices create a perfect storm of higher inflation, tighter monetary policy and the prospect of greater government borrowing.

What this makes me think of is this from the last Bank of England set of policy minutes.

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In the minutes of its meeting ending on 3 August 2022, the MPC said that it was provisionally minded to commence gilt sales shortly after its September policy meeting, subject to economic and market conditions being judged appropriate and subject to a confirmatory vote at that meeting. The Committee asked the Bank to be in a position to begin a sales programme before the end of September.

Selling into a declining market is really rather silly as they will exacerbate the fall. I have argued for many years that their plans for unwinding all their QE bond purchases were none too bright and they are proving me to be correct. They are essentially maximising their losses in capital terms if we look at recent events and prices.

As an aside this is something of a generic as central banks bought at record high prices for bonds and are now holding them at much lower ones. There is an issue of how all this will be accounted for. They cannot go broke as they can simply print but they have passed on interest profits to national treasuries.

Returning to the Bank of England the two-year yield is up by nearly 1.2% since it announced its QT plan to sell £40 billion a year of its bond holdings. How long can it last and will it even start are now relevant questions for it?

Today’s Data

That has not gone well either, because if we start from the basics we see that annual money supply growth rose from 4.4% to 4.8%. The M4 numbers are erratic on a monthly basis ( as last month’s fall now seems to highlight) but we have had 2 strong numbers out of the last 4 which is not quite what one might expect in a tightening round.

Also mortgage lending remains firm.

Net borrowing of mortgage debt by individuals decreased slightly to £5.1 billion in July, from £5.3 billion in June. This is above the pre-pandemic average of £4.3 billion in the 12 months up to February 2020.

As is consumer credit.

Individuals borrowed an additional £1.4 billion in consumer credit in July, on net, following £1.8 billion of borrowing in June (Chart 2). This is above the 12-month pre-pandemic average up to February 2020 of £1.0 billion. The additional consumer credit borrowing in July was split between £0.7 billion on credit cards, and £0.7 billion through other forms of consumer credit (such as car dealership finance and personal loans).

Indeed it did this.

The annual growth rate for all consumer credit increased to 6.9% in July; the highest rate since March 2019 (7.2%).


Events are presently fast moving and the Bank of England has been caught napping here. There is a further nuance because the Schnabel critique has a blatant flaw.

the potential costs of acting too late.

Collectively they are a year too late and maybe more. Also this is a laugh out loud moment.

the threats to central bank credibility

It is tempting to suggest that only a central banker could say that but there are more than a few around that believe that. Although if we exclude those who hope for a job at a central bank the field does thin out.

But her U-Turn left the Bank of England looking out of touch as events developed.


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