The Bank of England steps in...
Markets fall-out + Best time to start a business in 15 years + Boohoo profit warning + Podcast
The Bank of England has announced this morning that it is stepping in to buy long-dated government bonds because of the market chaos in recent days. This is a really significant and rare move and I will explain why below…
Here are some of the key extracts from the statement:
As the Governor said in his statement on Monday, the Bank is monitoring developments in financial markets very closely in light of the significant repricing of UK and global financial assets.
This repricing has become more significant in the past day – and it is particularly affecting long-dated UK government debt. Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability. This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.
And this…
The purpose of these purchases will be to restore orderly market conditions. The purchases will be carried out on whatever scale is necessary to effect this outcome. The operation will be fully indemnified by HM Treasury.
Finally…
These purchases will be strictly time limited. They are intended to tackle a specific problem in the long-dated government bond market. Auctions will take place from today until 14 October. The purchases will be unwound in a smooth and orderly fashion once risks to market functioning are judged to have subsided.
As a reminder, what has been particularly concerning about the movement in markets in recent days is that gilt yields have been going up sharply while the pound has been going down. This is unusual, and is why some economists said the UK was behaving like an emerging market.
The movement in gilt yields means the government has to pay more interest on its debt but it also causes problems for a whole load of other institutions who need these markets to get funding, including mortgage lenders and pension funds. Mortgage lenders have already had to scrap hundreds of deals or put up the interest rate on their other 2-year and 5-year mortgages to reflect the extra interest bill for them on the funding they are getting from money markets. However, my former colleague at The Times, Patrick Hosking, also wrote this piece this morning about how the surging yield on 30-year gilts was “inflicting huge and sudden cash calls on traditional pension funds that could damage the gilt markets”. He wrote:
Pension funds are suddenly being hit with repeated calls for cash as collateral from fund managers running so-called liability driven investment (LDI) funds on their behalf. The fund managers are in turn being hit by cash calls from investment banks that act as counterparties on the other side of the bet….
Pension funds are estimated to have about £400-£500 billion invested in LDI funds and the cash calls since Friday’s mini-budget have been running at billions of pounds a day.
Some pension funds are being forced to sell gilts, which forces down prices and pushes up yields. That in turn runs the risk of triggering fresh collateral calls and a fresh round of selling.
I recommend reading Patrick’s piece in full here. It is a great explanation of the problems the Bank is talking about.
This is the backdrop to why the Bank has stepped in as a buyer on long-dated gilts - ie 30-years - to try to stabilise the market and stop yields rising further. In simple terms it is a new round of quantitative easing. The decision was taken by its Financial Policy Committee, which is responsible for monitoring financial stability in the UK. It is separate from the rate-setting Monetary Policy Committee but its members include Andrew Bailey, the governor of the Bank of England, as well as Ben Broadbent, Sir Jon Cunliffe, and Sir Dave Ramsden, his deputies, and Nikhil Rathi, boss of the Financial Conduct Authority.
Here is some of the immediate reaction…
Finally, this is how the pound, two-year gilt yield and 30-year gilts have responded. The graphs show their movement over the last five days. These graphs were taken at midday on September 28 and you can see the reaction to the Bank’s statement at the far right…
The pound is still falling…
The two-year gilt yield fell on the news but is now rising again…
And this is the 30-year yield, which as you can see has risen remarkably over the last few days. It fell sharply on the Bank’s announcement but has started rising again too…
Podcast
A reminder that our Business Studies podcast is now available through all the main podcast platforms. You can listen on Substack here, Apple here and Spotify here. Episode 1 is an interview with Archie Norman, the chairman of Marks & Spencer. Bonus content from the interview is coming for paying Off to Lunch members on Friday, when I will also reveal the details of Episode 2…
A good time to start a business?
It might be the best time to start a business in 15 years according to one of the leading figures in the venture capital world. Bill Gurley made the comments in an interview with McKinsey, the consultancy firm. Gurley is general partner at Benchmark, where he has backed businesses including Uber, Nextdoor and Grubhub…
This is what he says in the interview about why it’s such a great time to launch a start-up:
I have two things in the back of my mind that relate to start-ups and the start-up ecosystem.
First, Stephen Covey used to talk about your circle of influence, and Buffett talks about your circle of competence. Macro things are not things that start-ups can impact or control. So there’s not much reason for them to affect your thoughts about whether you would start a company or not. They might add anxiety, but I don’t know that they have any real impact.
Second, the environment for launching a start-up was really crazy the past five years. And the truth is that if you’re going to build something from scratch, this might be as good a time as you’ve had in a decade.
Real estate? You can get all the real estate you want. People used to fret about lease cost, but that’s all gone. And while people get caught up on whether the money’s cheap or not, getting rid of the distraction of all that cheap money may be a good thing. That whole mentality of, oh, your competitor raised $100 million, now you have to raise $100 million. All those things have evaporated—for the better, I’d say.
A huge thing is that your access to talent is way better. It was so hard to get, but now it’s a lot cheaper than it was. There are layoffs happening. And then hybrid has opened up the people you can get. I’ve heard some pretty amazing stories.
It’s a really interesting interview and you can read the full Q&A here.
I have had multiple conversations with leading figures in the UK start-up world this week and the mood is more optimistic than you might think given the chaos in markets and the prospect of consumer spending being squeezed even more by rising monthly mortgage repayments. This is partly because there were measures in Kwasi Kwarteng’s mini-Budget that are helpful for start-ups, such as the extension of the Enterprise Investment Scheme and Venture Capital Trust - which offer tax relief on investments in new businesses - beyond 2025, and the expansion of the limits on the Seed Enterprise Investment Scheme and the Company Share Option Plan - which also offer tax breaks on investments.
“We haven’t seen anything drop off a cliff,” one boss in the start-up finance world said. They did caution that there was a “gap in expectations between founders and markets” when it comes to the valuation of businesses in funding rounds, which is leading to some being delayed or scrapped, and that founders looking to exit or sell their businesses have an issue because the window for floats on the stock market has slammed shut.
However, the weak pound makes UK assets even more attractive to international investors. Jeremy Warner says in his latest Telegraph column that there is a “generational opportunity” for buying UK assets. Given that many venture capital and private equity firms are still sitting on billions of dollars of money to spend after raising money from investors in recent years, and have opened offices in London and the UK, we are almost certain to see interesting M&A and investments in the coming months. This could end up helping the 138 infrastructure projects around the UK that the government has said it wants to prioritise but many of which still require funding.
Boohoo profit warning…
I think the graph below is fascinating. It shows the share prices over the last five years of M&S (white), Next (yellow) Associated British Foods, Primark’s owner (light blue), Asos (purple) and Boohoo (blue). As you can see, the two online retailers - Asos and Boohoo - have been the worst performers despite the supposed growth in online shopping and the surge in digital sales during the Covid-19 crisis. Next is by far the best performer.
Shares in Boohoo are down almost 10 per cent today after the company warned that profits for its financial year to the end of February would be lower than expected. The online retailer said it expected sales to fall in the rest of its financial year and that adjusted underlying profit margins were likely to be between 3 per cent and 5 per cent compared to previous guidance of 4 per cent and 7 per cent. Boohoo made the comments as it posted results for the first half of the financial year which showed a 10 per cent drop in revenues year-on-year to £882 million and a 90 per cent drop in adjusted profits before tax to £6.2 million. John Lyttle, Boohoo’s chief executive, said the company's performance had been “impacted by a more challenging economic backdrop weighing on consumer demand”…
A tweet that helps us understand the world…
These comments from Robert Chote, the former chairman of the Office for Budget Responsibility, in a speech in 2020 now look more relevant than ever…
Other stories that matter…
Really interesting long read on Britishvolt’s battle to build a gigafactory and electric vehicle battery business from scratch. As Off to Lunch has written before, the outcome of this project is important for the future of the UK car industry and levelling up, with the £3.8 billion gigafactory being built in Blyth, Northumberland. There are some alarming details in this piece, including that Britishvolt is burning through £3 million of cash every month just for salaries and that some staff have been offered share options and told they will be “millionaires” when the company floats. Britishvolt has made remarkable progress so far and raised money from blue-chip investors like Abrdn and Glencore, but the economic environment really isn’t helping (Financial Times)
Airbus has taken on the second largest number of apprentices and graduates ever this year at its UK facilities, which include its wing factory in Broughton, north Wales and its site in Filton, near Bristol. 144 apprentices, 53 interns and 20 graduates have joined the 4,500 workforce at Broughton while 68 apprentices, 69 interns and 71 graduates have joined at Filton (BusinessLive)
Apple is pulling back on plans to increase production of the new iPhone in a sign that demand for the new product may not be as strong as hoped (Bloomberg)
Bloomberg is publishing a list of the top 100 bars in the world. It has already published 100 to 51 and for the first time a bar in Manchester - or anywhere in the UK outside London or Edinburgh has made the list. It is Schofield’s Bar (Bloomberg and reaction in the Manchester Evening News)
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Best
Graham