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Does the UK need an emergency rate hike?

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Sterling’s crumbling and gilts are getting butchered after Britain’s embrace of trickle-down splashback economics. At time of pixel, cable’s at about $1.09. FT Alphaville sincerely hope everyone who hoped to travel abroad this year already did so.

As UK markets go all Red Wedding, what’s a central bank Governor to do?

ING’s Antoine Bouvet and Chris Turner reckon quantitative tightening, after getting the greenlight just yesterday, is now dead in the water (our emphasis):

We have written at length before that trading conditions in the gilt market call for the BoE to tread very cautiously when it comes to adding to the selling pressure already evident in gilt markets.

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A number of indicators, from implied volatility to widening bid-offer spreads, suggest that liquidity is drying up and market functioning is impaired. A signal from the BoE that it is willing to suspend gilt sales would go a long way to restoring market confidence, especially if it wants to maximise its chances of fighting inflation with conventional tools like interest rate hikes. The QT battle, in short, is not one worth fighting for the BoE.

But Deutsche Bank, which has argued the UK might be stumbling into a full-blown currency crisis, is pushing back against killing QT and calling for the Bank of England to come out swinging.

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Here’s DB’s George Saravelos this afternoon (our emphasis):

Both the pound and gilts are experiencing historical drops today. We are surprised to read some market commentary in recent hours suggesting that the appropriate monetary policy response to this extreme market volatility is for the Bank of England to reverse its planned sale of gilts.

In our view, such a policy response would make things worse. The market is giving very strong signals that it is no longer willing to fund the UK’s external deficit position at the current configuration of UK real yields and exchange rate. A monetary policy response to prevent bonds from selling off would not only prevent the necessary rise in real yield to attract foreign buyers, but it would lead the central bank dangerously close to a path of fiscal dominance: a situation where decisions by the fiscal authority (large fiscal spending) and their consequences (higher yields), dominate over the central bank’s primary inflation objective.

In view of this author, the policy response required to what is going on is clear: a large, inter-meeting rate hike from the Bank of England as soon as next week to regain credibility with the market. And, a strong signal that it willing to do “whatever it takes” to bring inflation down quickly and real yield in to positive territory.

Cool cool cool. So, err, hands in the sky if you’ve got that Friday feeling?

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