Convertible or not: making sense of stresses in AT1 bonds market

Mahmoud Fatouh and Ioana Neamțu

Similar to the Deutsche Bank’s episode in 2016 and the Covid stress in 2020, AT1 spreads over subordinated debt rose rapidly and sharply following the Credit Swiss rescue deal. Beyond these three cases, AT1 spreads have been stable. In this post, we focus on conversion risk of AT1 bonds (also known as contingent convertible, CoCo, bonds) to explain the sharp rise in AT1 spreads in these three cases. Conversion risk is the main additional risk of AT1 bonds, compared to subordinated debt. It arises from the potential wealth transfer from AT1 bondholders to existing shareholders when AT1 conversion is triggered, conditional on the solvency of the issuer. We show that, in normal times, investors believe conversion risk is very low, but major events can change this significantly, largely due to higher uncertainty.

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Bomadland: How the Bank of Mum and Dad helps kids buy homes

May Rostom

On average, parental contributions help children buy homes four years earlier than those without them. Out of every 100 new homeowners below the age of 30, 16 will have had help from ‘the Bank of Mum and Dad’, or Bomad for short. That rises to one in four new homeowners under the age of 25. Those who have had help from their parents put down a deposit twice as large, bought bigger first homes, and had smaller mortgage payments than those who did not. Anecdotes about cash assistance from Mum and Dad have recently been backed up by evidence from Legal & General, which implies Bomad plays a non-trivial role in the housing market. I attempt to investigate its prevalence.

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How have recent changes to the demand for workers affected the unemployment rate?

Tomas Key

During the recovery from the Covid pandemic, the demand for workers rose to unprecedented levels in the UK. The number of jobs that firms were looking to fill increased to 1.3 million in the middle of 2022, 60% higher than the level in the last three months of 2019. The amount of job vacancies has fallen substantially over the past year, but remains at a high level. This post discusses how those changes to the demand for workers have affected the unemployment rate. In particular, it outlines how an equilibrium model of the labour market can help to explain why there appears to have been a change to the relationship between job vacancies and unemployment in recent years.

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Lifting the lid on a liquidity crisis

Lydia Henning, Simon Jurkatis, Manesh Powar and Gian Valentini

Autumn 2022 saw some of the largest intraday moves in gilt yields in history. It was then that jargon normally confined to financial stability papers entered into mainstream commentary – ‘LDI’, ‘doom loop’, ‘deleveraging’. And it was then that the Bank of England engaged in an unprecedented financial stability motivated government bond market intervention. What happened and why has been set out in detail in official Bank communications. This article instead hovers a magnifying glass over transaction-level regulatory data on derivative, repurchase agreements (repo) and bond markets to quantify liability-driven investment (LDI) and pension fund behaviour and enrich our understanding of these exceptional few weeks of stress.

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Unknown measures: assessing uncertainty around UK inflation using a new Inflation-at-Risk model

Nikoleta Anesti, Marco Garofalo, Simon Lloyd, Edward Manuel and Julian Reynolds

Understanding and quantifying risks to the economic outlook is essential for effective monetary policymaking. In this post, we describe an ‘Inflation-at-Risk’ model, which helps us assess the uncertainty and balance of risks around the outlook for UK inflation, and understand how this uncertainty relates to underlying economic conditions. Using this data-driven approach, we find that higher inflation expectations are particularly important for driving upside risks to inflation, while a widening in economic slack is important for downside risks. Our model highlights that rising tail-risks can become visible before a turning point, making the approach a useful addition to economists’ forecasting toolkit.

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Dissecting UK service inflation via a neural network Phillips curve

Marcus Buckmann, Galina Potjagailo and Philip Schnattinger

Understanding the origins of currently high inflation is a challenge, since the effects from a range of large shocks are layered on top of each other. The rise of UK service price inflation to up to 6.9% in April might potentially reflect external shocks propagating to a wider range of prices and into domestic price pressures. In this blog post we disentangle what might have contributed to the rise in service inflation in the UK using a neural network enhanced with some economic intuition. Our analysis suggests that much of the increase stems from spillovers from goods prices and input costs, a build-up of service inflation inertia and wage effects, and a pick-up in inflation expectations.

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Firm inflation perceptions and expectations: evidence from the Decision Maker Panel

Ivan Yotzov, Nicholas Bloom, Philip Bunn, Paul Mizen, Ozgen Ozturk and Gregory Thwaites

Since late 2021, annual CPI inflation in the UK increased sharply. Alongside this increase, there was also a significant rise in firm and household short-term inflation expectations. In this post, we use data from the Decision Maker Panel (DMP), a UK-wide monthly business survey, to study whether there is an effect of CPI data releases on firms’ current inflation perceptions and year-ahead inflation expectations over the past four years. We find that on average firms’ perceptions of current CPI inflation have been close to the eventual outturn. Furthermore, one-year ahead own-price expectations respond significantly to CPI outturns, with the effects being particularly strong since the start of 2022.

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Did supply constraints tilt the Phillips Curve?

Ambrogio Cesa-Bianchi, Ed Hall, Marco Pinchetti and Julian Reynolds

The remarkable stability of US inflation dynamics in the pre-Covid era had led many to think that the Phillips Curve had flattened. However, the sharp rise in inflation that followed the Covid-19 pandemic ignited a debate on whether the Phillips Curve had steepened and, in particular, whether its slope depends on some particular macroeconomic conditions. Which are these conditions, though? In this post, we argue that one important candidate that could explain this kind of state-dependency in the slope of the Phillips Curve is global supply chain constraints. We propose a simple framework to account for this state-dependency, and conduct econometric analysis on US data which supports its implications – showing that inflation in the US is more responsive to slack when supply constraints are tighter.

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Funding structures and resilience to shocks after a decade of regulatory reform

Kristin Forbes, Christian Friedrich and Dennis Reinhardt

Recent episodes of financial stress, including the ‘dash for cash’ at the onset of the Covid-19 (Covid) pandemic, pressure in the UK’s liability-driven investment funds in 2022, and the collapse of Silicon Valley Bank in 2023, were stark reminders of the vulnerability of financial institutions to shocks that disrupt liquidity and access to funding. This post explores how the funding choices of banking systems and corporates affected their resilience during the early stages of Covid and whether subsequent policy actions were effective at mitigating financial stress. The results suggest that policy responses targeting specific structural vulnerabilities were successful at reducing financial stress.

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How house prices respond to interest rates depends on where they are in the country

Danny Walker

Many people expect the rise in interest rates over the past 18 months to lead house prices to fall. Average prices have already fallen by 1–2% in the UK and by more in the US. In this post I show that historically there have been large differences in how an interest rate shock affects prices in different areas of the country, even though interest rates are determined nationally. House prices respond more to interest rates in areas with more restrictive housing supply, like London and the South East of England. These are also the areas where price growth has been strongest in recent decades.

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