MNI INTERVIEW: BOE Hikes May Be Destabilizing-Blanchflower

Aggressive rate hikes from the Bank of England may heighten the risk of instability, former Monetary Policy Committee member David Blanchflower told MNI, adding the distress experienced by UK pension funds in a dysfunctional gilts market could easily spread to other parts of the global financial system.

“Stability is much more fragile than everybody thought, including in the United States,” Blanchflower said in an interview. “If last Monday every pension fund in the UK was about to fold, why would you not think that that might affect Vanguard or Fidelity or Schwab? Why would you not think that there was some global thing to this?”

The ex-central banker said this puts an already-challenged BOE in an even more tenuous position, as it tries to quell the pension crisis and proceed with plans to actively sell gilts amid political turmoil which has shaken both the pound and debt markets. BOE Chief Economist Huw Pill has said that a “significant” monetary policy response would be required following plans for unfunded tax cuts, though question marks now hang over the future of government policy following news of the dismissal of Chancellor Kwasi Kwarteng.

“It’s a dilemma for them now, I don’t think they can hike because the evidence of collapse is too high,” said Blanchflower, now a professor at Dartmouth College. “There’s an argument to hike rates but a case could also be made for why they might need to cut them.”

He cited a freezing of the mortgage market last week due to interest rate volatility as a sign that further monetary tightening could be problematic, arguing the UK economy is already in recession.

GAME OF CHICKEN

Blanchflower said BOE Governor Andrew Bailey’s ultimatum to markets earlier this week, when he said that special gilts purchases meant to allow pension funds to improve liquidity would conclude as planned on Oct. 14, amounted to an ill-advised game of chicken that the central bank could lose at a high cost to its credibility.

“They’re not going to be able to stop” buying gilts at the Friday deadline, he said. “Maybe he wasn’t talking to the markets – maybe he was talking to 10 Downing Street.”

“Now markets are going to test it. The analogy is you do surgery on Monday you say you better be well by Friday. Well good luck with that. Sometimes they are, sometimes they aren’t. How can you rule out complications? You can’t,” he added.

A policy U-turn on the tax cut plans won’t end the UK’s financial troubles, he said.

“The pandora’s box has been opened. Then the question is are there global implications, and the answer is yes,” he said. “We were worried about how some big shoe was going to drop. Well, that’s it.”