The Banker and Bailey Circus

Governor of the Bank of England Andrew Bailey addresses the media on the Monetary Policy Report, London, Aug. 4.


yui mok/Agence France-Presse/Getty Images

The Bank of England’s decision Wednesday to buy British bonds is being portrayed as a rebuke to new Prime Minister

Liz Truss’s

economic program, and BOE Governor

Andrew Bailey

may have meant it to be. The intervention calmed bond and equity markets, at least for now, though at the cost of showing again that central bankers are easily spooked into rescue mode.

Investors are cheering their success in coaxing the Bank of England back into the market to underwrite bond prices. On Monday the BOE issued a statement saying it would evaluate market movements “at its next scheduled meeting,” which is in November. Two days later it had forgotten all that and said it would “carry out temporary purchases” of longer-term gilts “to restore orderly market conditions.”

The cause of the market ructions is supposedly the Truss government’s proposals for new tax cuts and spending to ease the burden of rising energy prices. That’s a convenient scapegoat for Mr. Bailey and other central bankers, but that isn’t the half of it.

Markets began heading south last week when the Federal Reserve lifted rates by 75 basis points again and signaled that more increases are coming to fight inflation. Mr. Bailey’s BOE followed by raising its target rate only 50 basis points.

The different central bank moves widened the disparity in monetary tightening that has pushed the dollar to new heights against nearly all of the world’s currencies. The Chinese yuan fell Wednesday to its lowest rate to the dollar, 7.2 per buck, since 2008. The euro is now below parity with the greenback.

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Central bankers have given up on monetary policy coordination, so investors are betting on (and contributing to) rapid exchange-rate shifts as they play the policy margins. This uncertainty is damaging to investment and trade flows, and it also contributes to disorderly market moves that catch some investors naked on the beach. Ditto for sharp moves in bond prices, as the 10-year British gilt popped above 4.5%. On Sept. 22 it was 3.3%.

Amid this turmoil, markets understandably loved the BOE’s intervention, and the scuttlebutt is that the central bank moved in part because big British pension funds and financial institutions were caught on the wrong side of these rapid shifts in market prices. We can’t judge without knowing the details.

But there’s no doubt that the BOE’s intervention now has the bank working at cross purposes with its monetary mission. The BOE’s Monetary Policy Committee wants to tighten policy to break inflation. At its last meeting it said it would be selling down its quantitative-easing bond portfolio. But the BOE’s Financial Policy Committee is now buying bonds to ease financial conditions. This can’t help the BOE’s credibility as it navigates the fraught path away from the historic monetary mistakes that have produced our current inflation.

This is one of the reasons that sneering at Ms. Truss and the Brits from the American cheap seats is a mistake. There but for the relative strength of the dollar go we. For all the fretting about British debt, the U.K.’s total debt to GDP ratio (86%) is lower than America’s (127.5%) and its interest expense as a share of GDP is lower. The saving U.S. grace is the dollar’s status as a global reserve currency.

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The larger story here goes back to the blunders by the Fed and other central banks in letting policy run amok, and then dismissing the signs of emerging inflation as “transitory.” Too many investors began to believe the Fed’s advertising and thought money would be risk-free forever. They made bets that made sense at near-zero interest rates but that look a lot uglier when fed funds are heading to 4% and maybe 5% or higher.

The big surprise so far during this great monetary correction has been the lack of a big financial casualty. There’s been no Orange County (1994), no Long-Term Capital Management (1998), and no

Fannie Mae

(2008). But then again, maybe the British pound and bond panic is a sign of what is coming.

One policy response would be for the big central banks to start coordinating again to reduce uncertainty and volatility. The Fed could also reopen dollar swap lines to help other economies with liquidity as the greenback keeps rising. The hard truth is that correcting for the inflation blunder was always going to be painful, and that is what the banker and Bailey circus is telling us.

Review and Outlook: U.K. Prime Minister Liz Truss’s battle for economic growth has begun, following years of stale Keynesian policy consensus that has produced stagflation everywhere. Images: Zuma Press/PA Images via Getty Images Composite: Mark Kelly

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Appeared in the September 29, 2022, print edition.

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