London
DailyExpertNews Business
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A week ago, the Bank of England took a stab in the dark. It raised interest rates by a relatively modest half a percentage point to address inflation. It could not know the magnitude of the storm that was about to break.
Less than 24 hours later, the government of new British Prime Minister Liz Truss unveiled its plan for the biggest tax cuts in 50 years, pushing hard for economic growth but leaving a huge hole in the country’s finances and its credibility with investors.
The pound plunged to a record low against the US dollar on Monday after British Chancellor of the Exchequer Kwasi Kwarteng doubled his bet by hinting at more tax cuts without explaining how they would pay for them. Bond prices collapsed, sending borrowing costs soaring, causing chaos in the mortgage market and pushing pension funds to the brink of insolvency.
Financial markets were already in a frenzy due to the mounting risk of a global recession and the swings caused by three excessive rate hikes by a US central bank on a warpath against inflation. In that “pressure cooker” the new British government stumbled.
“You have to have a strong, credible policy and any policy misstep is punished,” said Chris Turner, Global Head of Markets at ING.
After verbal pledges from the UK Treasury and the Bank of England failed to appease the panic — and the International Monetary Fund issued a rare reprimand — Britain’s central bank withdrew its bazooka, saying on Wednesday it would pay £65 billion ($70 billion). to press. to buy government bonds between now and October 14 — essentially protecting the economy from the effects of the Truss’ growth plan.
“While this is welcome, the fact that it had to happen in the first place shows that UK markets are in a dangerous position,” said Paul Dales, UK chief economist at Capital Economics, of the bank’s intervention.
The emergency room stopped the bleeding. Bond prices recovered sharply and the pound stabilized against the dollar on Wednesday. But the wound has not healed.
The pound tumbled 1% and fell back below $1.08 early Thursday. UK government bonds were again under pressure, with the yield on 10-year debt rising to 4.16%. UK stocks fell 2%.
“It wouldn’t be a big surprise if another problem emerged in the financial markets soon,” Dales added.
The coming weeks will be crucial. Mohammed El-Erian, who once helped run the world’s largest bond fund and now advises Allianz (ALIZF), said the central bank bought some time but needed to act quickly to restore stability.
“The patch can stop the bleeding, but the infection and the bleeding will get worse if they don’t do more,” he told DailyExpertNews’s Julia Chatterley.
The Bank of England should announce an emergency rate hike of a full percentage point before its next scheduled meeting on November 3. The UK government should also delay its tax cuts, El-Erian said.
“It’s doable, the window is there, but if they wait too long, that window will close,” he added.
The UK government has been previewing announcements in the coming weeks on how it plans to change immigration policy and make it easier to build major infrastructure and energy projects to boost growth, culminating in a budget on 23 November on which it promised to publish a detailed document. plan to reduce debt in the medium term.
But it shows no signs of withdrawing from the fundamental policy choice to borrow heavily to fund tax cuts that will mainly benefit the wealthy at a time of high inflation. And the UK Treasury says it will not bring forward the November announcement.
Truss, who spoke publicly for the first time since the crisis broke out, blamed global market turmoil and the shock in energy prices following Russia’s invasion of Ukraine for this week’s chaos.
“This is the right plan that we have mapped out,” she told local radio on Thursday.
A major problem identified by investors, former central bankers and many leading economists is that her government has only drawn up half a plan at best. It went ahead without an independent assessment by the country’s budget watchdog of the assumptions underlying the £45 billion ($48 billion) annual tax cuts and their long-term impact on the economy. It fired the top finance ministry official earlier this month.
Charlie Bean, former deputy governor of the Bank of England, told DailyExpertNews Business that the government was guilty of “really stupid” decisions. His former boss at the bank, Mark Carney, accused the government of “undercutting” British economic institutions, saying this contributed to the “big blow” to the country’s financial system this week.
“This is an economic crisis. It’s a crisis…that can be addressed by policymakers if they choose to address it,” he told the BBC.
British newspapers are beginning to speculate that Truss Kwarteng, her close friend and political soul mate, will have to fire if she wants to regain political initiative and prevent her government’s bad polls from falling further.
“Every problem we have now is our own. We look like reckless gamblers who only care about the people who can afford to lose the gamble,” a former Conservative minister told DailyExpertNews.
But for now, she’s trying to fight it out and stick with the Reaganite experiment.
“Increasing, delaying or abolishing tax cuts will be avoided by Truss at all costs, as such a rollback would be humiliating and could make her look like a crippled prime minister,” wrote Mujtaba Rahman and Jens Larson at the political risk consultancy. Eurasia Group.
The only alternative left to balance the books would be to cut government spending, and that would prove to be just as difficult politically as the country plunges into recession with its public services under immense pressure and an unsettled workforce. that has shown that it is ready to strike in large numbers about paying.
“Truss and Kwarteng are now facing a severe economic crisis as the world’s financial markets wait for policy changes that they and the conservative party will find unpalatable,” the Eurasia analysts wrote.
The foreign investors who keep the UK economy solvent will be left scratching their heads for another eight weeks, leaving plenty of time for doubts about the UK government’s commitment to responsible fiscal policy-making.
“The message from the financial markets is that in this environment there is a cap on unfunded spending and unfunded tax cuts and the price of that is much higher borrowing costs,” Carney said.
That leaves the Bank of England in a difficult position. It was busy a week ago the brakes on the economy to discourage price increases, even as the government tried to slow growth. The task was made even more difficult this week when it was forced to dust its crisis book and save the government.
It won’t be long before it has to intervene again, this time with an emergency rate hike.
“[Wednesday’s] The intervention is designed to stabilize UK government bond prices, keep the bond market liquid and prevent financial instability, but that won’t necessarily prevent the pound from falling further, with the associated inflationary consequences,” said Bean, the former central banker. to DailyExpertNews Business.
“I think there’s still a good chance they’ll have to act before the November meeting,” he added.
— Julia Horowitz, Luke McGee, Anna Cooban, Rob North, Livvy Doherty, and Morgan Povey contributed to this article.
