Why fears over inflation are set to dominate a bleak midwinter - Greg Wright

Chancellor Kwasi Kwarteng has endured a hellish start to his occupancy of Number 11 as the new administration has struggled to get on the front foot and drive ahead with its “pro-growth” agenda.

The Bank of England’s latest attempt to calm the market chaos followed another tough time for the pound and UK government bonds.

This unwelcome development caused more analysts to question the Chancellor’s economic strategy.

The Bank said it needed to broaden the emergency programme to buy UK government bonds – also known as gilts – to calm markets as it warned over a “material risk to UK financial stability”.

It came after a further sell-off in the gilt market, which saw the yields on long-dated government bonds rise back up close to levels seen in the immediate aftermath of the mini-budget. A gilt is essentially an IOU that the Treasury writes to its lenders, promising to pay the money back, plus interest, within a time frame, for example over two, 10 or 30 years.

The yield on a gilt is the amount of money an investor receives for owning the debt and is represented as a percentage of its price. When a bond price falls, its yield rises.

Yields rise when investors are less willing to own the debt, meaning they will pay a lower price for the bonds.

Concerns over the Chancellor’s plans for unfunded tax cuts sent gilt yields soaring as markets continued to register doubts over the Government’s economic policies.

At one stage, the yield on 30-year gilts hit levels not seen since 2002 in the chaos that followed the mini-budget statement, while the pound also plunged to record lows against the US dollar.

Pension funds invest huge amounts of money in gilts, which are seen as safe investments in normal times. In order to protect themselves against sharp rises in Government borrowing costs, funds have been investing in products that act as a kind of insurance – so-called liability driven investment (LDI) funds.

However, due to the sudden rise in Government borrowing costs after the mini-budget, investment banks called on these LDIs to put up assets or cash as securities for loans, which in turn called on pension funds, forcing them into a fire sale of gilts, driving prices still lower and yields higher and creating a downward spiral.

There are concerns that when the Bank’s programme comes to a close on October 14, there will be a further sell-off of gilts, leaving pension funds in chaos once more.

The Pensions and Lifetime Savings Association (PLSA) has called for the bond-buying programme to be extended to the Chancellor’s next fiscal statement on October 31 or even beyond, suggesting there may yet be further intervention from the Bank.

There may well be troubling times ahead. To quote Andy Verity, the BBC’s economics correspondent, who said on Twitter: “What the bond market has rejected is the idea that cutting taxes the way Kwasi Kwarteng has announced will achieve growth without stoking inflation so it becomes more permanently embedded.”

Fears of inflation becoming embedded will keep the policymakers of the Bank of England awake at night as we head into a bleak and penny-pinching midwinter.

Greg Wright is deputy business editor of The Yorkshire Post