Not to panic anyone, but things are not looking good for the Great British Krona.
Firstly there’s the BoE minutes today. A unanimous vote, and policy which suggests the door is clearly opened for further dramatic cuts. From the minutes:
On balance, the Committee judged that an immediate reduction in Bank Rate of 1.5 percentage points to 3% was necessary to meet the 2% target for inflation in the medium term. At future meetings, the Committee would be able to reassess the developments in the economy taking into account the potential impact of any fiscal announcement, as well as the reaction of the exchange rate and financial markets more generally to the November interest rate decision and to the publication of the November Inflation Report. 39 The Governor invited the Committee to vote on the proposition that Bank Rate should be reduced by 1.5 percentage points to 3.0%. The Committee voted unanimously in favour of the proposition.
All eyes now on the government’s pre-budget report this Monday.
According to Howard Archer, Chief UK & European economist at Global Insight, just how much fiscal stimulus will be decided by the government will determine the exact size of the Bank of England interest rate cut in December but anything as sharp as another 100 basis points is possible.
If the government’s planned stimulus is at the top end of the £15-30 billion range being bandied about, then the Bank of England is unlikely to cut interest rates by more than 50 basis points from 3.00% to 2.50% in December. However, a smaller fiscal stimulus could well see the bank cut interest rates by another 100 basis points to 2.00% next month given the sharper-than-expected drop in consumer price inflation in October and rising fears that deflation could occur next year. Further out, interest rates seem ever more likely to fall as low as 1.00% in 2009.
According to Investec, the report will be the most significant one since the government came to power in 1997. Some sort of fiscal measure is inevitable. And yet, Britain’s finances are hardly in the shape to help, meaning all government rules on borrowing will likely be broken. Investec says:
Overall we prefer to avoid specific guesswork on the size of the fiscal package, but simply to conclude that it will be major. There is no magic wand to end the recession in the near-term, but a substantial fiscal boost could attenuate the downturn.
The expectation is that the fiscal measures will be concentrated on helping lower income workers and small businesses. But, the expectation is also that they will be described as transitory. Meanwhile, gilt sales are likely to continue their explosion to an all-time record issuance.
The public finances and outlook for gilt sales have deteriorated alarmingly over the last eight months. As detailed above, our forecasts for PSNB have worsened sharply, from a not-altogether-healthy starting point. Additionally, the government’s banking rescue measures have already added £37bn to the CGNCR (central government net cash requirement) and we assume a further £13bn (to total the £50bn suggested on 8 October) is used in Q1 2009. The government has already announced that this £37bn will be financed in part through an increase in T-bill sales.
However, assuming that gilt sales bear the brunt of any remaining worsening, we envisage gross gilt sales rising to £143.5bn or 9.6% of GDP this year — likely an all time record for gilt issuance. On our PSNB forecasts, the financing requirement should moderate in 2009-10, but the outlook for 2010-11 is uncertain and may yet keep gilt sales excruciatingly high.
How the gilt market reacts is key however. Investec reminds that unlike 1993-94, which was the last time the UK saw a comparable increase in sales, this time round gilts will be competing on a large scale with other international borrowers.
Related links:
Prsh-dum, Prsh-dum, Prsh-dum - FT Alphaville
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