ALEX BRUMMER: The Bank of England opens a new front

Mark Carney had just finished an interview at the IMF with an American television network in the aftermath of Brexit when he casually remarked to the travelling press that the stability of sterling would depend on the ‘kindness of strangers’.

Several years after the former Governor of the Bank of England’s comments and the muddled handling of the gilts market turbulence by his successor Andrew Bailey, that predication sadly could become a reality.

The mini-Budget fiasco and the Bank’s interventions in the bond market to save defined benefit pensions have tested faith in Britain as a safe place to invest.

The UK runs a substantial deficit on the current account of the balance of payments which has widened amid the adjustment to Brexit and the pandemic.

But as a favourite European destination for overseas investment and a country with strong earnings inflows from the operations of UK global firms overseas, the financing has never seemed a real concern.

Indeed, because many of these global entities have large dollar incomes, they benefit from sterling’s 20 per cent or so depreciation in 2022. The latest Bank of England Financial Stability Report raises a red flag over external financing.

It might be asked why on earth should anyone take any notice of Bank warnings, given its own failings in following up on its 2018 caution about the use of liability-driven investments (LDIs) in repairing the holes in UK pensions.

Nevertheless, amid the current turmoil, which has undermined faith in gilts and sterling, one has to take the Bank’s words seriously. 

It notes that the UK’s financing of its current account is supported by a positive net investment position – the inflows of capital and earnings from the investments of British entities overseas.

But nothing lasts forever. The reliance on strangers and friends to finance the UK’s needs could turn as quickly as the sentiment in the market for government bonds.

If the normally enthusiastic foreign investor appetite for UK assets and overseas takeovers remains unabated, then the Bank says there could be tighter credit conditions. In other words: higher interest rates for UK firms and households.

Moreover, because some of the UK’s overseas holdings are leveraged, there could also be refinancing risks in a fractious global economy. None of this really takes account of overseas interest in UK high tech, pharma, satellites and much else.

Even so, Britain has never needed its friends in the Gulf, Norway, France (a huge investor in new nuclear) and the US more.

Fiscal retreat

In the appendices of the online International Monetary Fund Fiscal Monitor report there is a perplexing table.

It shows the ratios of gross government debt to national output, a key measure for assessing budget sustainability.

According to this league table (prepared before Kwasi Kwarteng’s mini-Budget) it shows the UK debt-to-GDP ratio to be 79.9 per cent, falling to 68 per cent in four years.

When compared to most of our competitors in the G7 richest countries, this makes Britain look a cut above the rest. 

With the exception of Germany, where the debt-to-GDP ratio stands at 71.1 per cent, the others start out with deficits well above 100 per cent, with Japan at 263.9 per cent and the US at 122.9 per cent.

The UK numbers are unsafe because of Kwarteng’s decision to roll back the corporation tax rise and national insurance surcharge. 

But even in the worst-case scenario of the Institute for Fiscal Studies, which put the mini-Budget cost at £60billion, it is not going to move the debt dial far unless one builds in four years of appalling growth.

Why, then, the market ructions? The IMF, which came down hard on the Chancellor’s fiscal event, is in full retreat, having embarrassed the British government.

Fiscal chief Vitor Gaspar has gone out of his way to praise the Treasury, the Bank of England and the Office for Budget Responsibility (OBR) as well functioning institutions. And he is looking forward to the OBR report on October 31.

What a change from the top.

Missing person

External Bank of England monetary policy committee member Catherine Mann was meant to be the star turn at the Peterson Institute for International Economics today.

The event has been cancelled as the cliff edge for the Bank’s gilts intervention approaches. Wonder why?