The UK government’s "mini-budget" of massive tax cuts has sent the country’s bond and currency markets into disarray, leaving the BOE with little option other than to resume bond purchases. However, investors should not take this as a sign that the global fight against inflation, and the economic collateral that comes with it, is being renounced.

UK government bond yield
30-year Gilt, 5-day change, bps, 1994-present

Chart showing the UK 30-year Gilt yield, 5-day change, bps, from 1994 to 2022, with 2022 being at an all time high around 150 bps

Bank of England, Bloomberg, Principal Global Investors. Data as of September 29, 2022.

The United Kingdom has moved firmly into center stage in recent days. The government’s announcement of massive, unfunded, tax cuts has ravaged the country’s bond and currency markets, giving the Bank of England (BOE) little choice but to temporarily resume bond purchases.

Some investors have cheered the developments, misinterpreting them as evidence that central banks worldwide will put aside inflation concerns as bond yields soar and growth prospects deteriorate.

While it’s true that quantitative easing conflicts with fighting inflation, the BOE’s decision was not driven by economic growth concerns. Instead, it was designed to avoid a UK-specific bond market dysfunction which, without intervention, would have potentially collapsed several large UK pension funds.

The BOE’s relationship with inflation has become complicated but hasn’t been abandoned. In fact, even while the BOE is purchasing bonds, it is expected to accelerate rate hikes, with markets expecting back-to-back 100 basis point hikes at the central bank’s next two meetings.

In recent days, governments have learned that it takes just one week to unravel an advanced economy. The more important takeaway, however, is that using fiscal stimulus to offset the negative impact from tighter monetary policy will not be well-received by financial markets. There is no alternative route for policymakers: Inflation must be tamed, and economic growth will be collateral damage.



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