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Rola Khalaf, the Vinonghol Times editor, chooses her favorite stories in this weekly newsletter.
author He is the first vice president and economist at Pimco
The returns of British government bonds began at a volatile start for this year. After height sharply in the first two weeks – about 0.3 percentage points for government bonds for five years – they are now returning to where they started. Despite the noise surrounding the financial policy, the moves were largely driven by global factors. American bond returns have shown similar fluctuations.
UK bond markets may be more sensitive to financial credibility in the wake of the turmoil that followed the Liz Trusse budget for 2022. But the financial sustainability in the UK is not significantly different from some of its peers, including France, which suffers from a higher financial deficit and debt rising rapidly greater.
However, the United Kingdom remains an anomaly on the other side of the policy book. Now, the basic interest rate approved by the Bank of England has become 4.75 percent, is the highest among the major developed countries. This affects the activity. Economic growth has witnessed stagnation since the summer, and the demand for employment decreased sharply. The inflation rate has declined last year and is now in the “two points”, that is, close to the goal of the Bank of England of 2 percent. It is not surprising, then, for the Bank of England to repeat at its meeting in December its intention to reduce the interest rate in the future.
But to what extent will you decrease? Unlike many other central banks, the England Bank He did not provide clear directions. Estimating the balance rate, where the monetary policy is not extremist or loose, requires a great deal of humility. This depends on the factors affecting the supply and demand on the capital, which change naturally over time.
The simple way to estimate it is by looking at economic growth. High growth countries attract more investment and encourage savings, which leads interest rates to rise. With this scale, the long -term interest rate expected on the UK market appears high. The productivity increased only by 0.5 percent (annually) since the epidemic began, which is just below the pre -epidemic and less than a third of its counterpart in the United States – and actual productivity may be less due to the ongoing problems related to the workforce scanning data, which may be less than Employment levels.
Inflation imposes ascending pressure on interest rates as well. Although the basic inflation in the UK – which reached 3.2 percent over the past year – is still slightly higher than it is in most other developed countries, it is heading towards a decrease. The basic price pressures, with the exception of tax shocks for one time, are witnessing a decline, especially in the services sector. Based on medium term inflation expectations, the Central Bank's credibility is sound, and we see only few reasons that may make the UK inflation rate higher than other countries.
However, the markets are still skeptical, and only a few discounts expect before reaching the final destination of about 4 percent. These expectations may reflect fears that increasing government spending may lead to high inflation. The markets may also question the extent of the government's commitment to its new financial rules, given its modern date of amendments. Like Italy, but in contrast to most of the other large developed countries, the UK borrows money at a much higher interest rate than its basic economic growth rate, which exacerbates debt dynamics.
We have a more moderate central point of view in terms of inflation, even if we admit that the fiscal policy adds a state of uncertainty. Although government spending increases, taxes will also rise, making fiscal policy hardliner. The net effect is likely to affect activity and employment, as it is already evident in recent surveys. Companies may pass some increase in national insurance to consumers, but this will be a modification of the price level – such as value -added tax or increased customs duties. Usually, this is something central banks view. We will be very surprised if the government does not amend taxes or spending to meet its financial bases, given the recent fluctuations in the bond market.
As such, we expect Gold returns in the United Kingdom Decreased. The return on government bonds for five years is now only a small percentage of that in the United States, and we expect to decrease below the American level over time, similar to the five years before the epidemic. While the risk of high interest rates is still standing – inflation expectations have increased in the short term in recent months – there are more reasons for expecting low interest rates, due to the increase in uncertainty in global trade, strict financial policy, and weak growth expectations in general.
As for the interest rate, our internal models indicate a neutral interest rate ranging from 2 to 3 percent in the United Kingdom. Even if the Bank of England is cautious about interest rate discounts in the first half of this year, we see a room for a decrease in the interest rate of more than the market expectations. The Bank of England may eventually follow other central banks, including the European Central Bank, Canada Bank, New Zealand Reserve and the Swedish Central Bank in the shift towards faster discounts.
