The UK is in an economic crisis of its own making

London
CNN Business
–

A week ago, the Bank of England was stabbed in the dark. He raised interest rates by a relatively modest half a percentage point to tackle inflation. He didn’t know the size of the storm that was about to collapse.

Less than 24 hours later, British Prime Minister Liz Truss’s new government unveiled its plan for the biggest tax cuts in 50 years as it drives economic growth, but it has left a huge hole in the country’s finances and credibility with investors.

Sterling fell to a record low against the US dollar on Monday after British Finance Minister Kwasi Quarting doubled down on his bet by hinting at more tax cuts to come without making clear how they would be paid. Bond prices collapsed, driving up borrowing costs, wreaking havoc in the mortgage market and pushing pension funds to the brink of bankruptcy.

Financial markets were already on a fever pitch due to the rising risks of a global recession and the volatility caused by three massive interest rate hikes from a US central bank on the way to the war against inflation. In this “pressure pot” the new UK government stumbled.

“You have to have strong and credible policies in place, and any policy mistakes are punished,” said Chris Turner, head of global markets at ING.

After verbal assurances from Britain’s Treasury and Bank of England failed to calm the panic – and the International Monetary Fund provided a rare reprimand – the Bank of England withdrew its bazooka system, saying Wednesday it would print 65 billion pounds ($70 billion) To buy government bonds between now and October 14 – essentially protecting the economy from the fallout from Truss’ growth plan.

“While this is welcome, the fact that it has to be done in the first place shows that UK markets are in a precarious position,” said Paul Dills, chief UK economist at Capital Economics, commenting on the bank’s intervention.

Emergency first aid stopped the bleeding. Bond prices rebounded sharply and the pound stabilized on Wednesday against the dollar. But the wound did not heal.

pound It is down 1%, falling back below $1.08 early Thursday. UK government bonds came under pressure again, with the yield on 10-year debt rising to 4.16%. British stocks fell 2%.

“It wouldn’t be a huge surprise if another problem emerged in the financial markets soon,” Dills added.

The next few weeks will be crucial. Mohamed El-Erian, who once helped manage the world’s largest bond fund and now advises Allianz Corporation (ALIZF), said the central bank had bought some time but would need to move quickly again to restore stability.

“Band-Aid may stop the bleeding, but the infection and bleeding will only get worse if they don’t do more,” said Julia Chatterley, a CNN reporter.

El-Erian said the Bank of England should announce an emergency rate hike of a full percentage point before its next meeting scheduled for November 3. The British government should also delay tax cuts.

“It’s possible, the window is there, but if they wait too long, that window will close,” he added.

The UK government has reviewed the announcements taking place in the coming weeks on how it plans to change immigration policy and facilitate the construction of large infrastructure and energy projects to boost growth, culminating in the budget on November 23 in which it promised to publish a detailed report. debt reduction plan in the medium term.

But it shows no sign of backsliding from the basic policy option of borrowing heavily to fund tax cuts that will mainly benefit the rich at a time of high inflation. Britain’s Treasury says it will not make the November announcement.

Truss, speaking publicly for the first time since the crisis erupted, blamed turmoil in global markets and an energy price shock from Russia’s invasion of Ukraine for this week’s chaos.

“This is the right plan that we have put in place,” she told local radio Thursday.

One of the big problems identified by investors, former central bankers, and many prominent economists is that her government has developed only half a plan at best. It went ahead without an independent assessment from the country’s budget watchdog of the assumptions behind the annual tax cuts of 45 billion pounds ($48 billion), and their long-term impact on the economy. She fired the Treasury Department’s top civilian employee earlier this month.

Charlie Bean, a former deputy governor of the Bank of England, told CNN Business that the government was guilty of making “really stupid” decisions. Its former boss, Mark Carney, accused the government of “undermining” the UK’s economic institutions, saying it contributed to the “big blow” that the country’s financial system has suffered this week.

This is an economic crisis. He told the BBC that it is a crisis … that policymakers can tackle if they choose to tackle it.

British newspapers have begun to speculate that Truss will have to sack Kwarteng, her close friend and political close friend, if she is to regain the political lead and prevent her government’s horrific poll ratings from slipping further.

“Every problem we have now is a problem of our own making. We look like reckless gamblers who only care about people who can afford to lose their gambles,” a former Conservative minister told CNN.

But for now she’s trying to get over it, clinging to Reagan’s experience.

Mojtaba Rahman and Gens Larsson of political risk consultancy Eurasia Group wrote: “Terses will avoid raising, postponing or giving up tax cuts at all costs because such a reversal would be humiliating and could make her look like a lame prime minister.”

The only alternative left to balance the books would be to cut government spending, and this would prove to be equally politically difficult as the country enters a recession with its public services under enormous pressure and a restless workforce that has shown itself ready to strike in droves around the clock. Pay.

“Truss and Quarting now face a severe economic crisis as global financial markets await them to make policy changes that they and the Conservative Party will find unpalatable,” wrote the Eurasia analysts.

Foreign investors who are keeping the British economy’s ability to pay off are left in a quandary for another eight weeks, leaving plenty of time for doubts to resurface about the UK government’s commitment to responsible fiscal policymaking.

“The message from financial markets is that there is a limit to unfunded spending and unfunded tax cuts in this environment, and the price tag is much higher borrowing costs,” Carney said.

This leaves the Bank of England in an awkward position. A week ago it was urgent The brakes are on the economy to shake off rising prices, even as the government has tried to boost growth. The task became more difficult this week when she had to dust off the rules of the game for the crisis and bail out the government.

It may not be long before you have to step in again, but this time with an emergency rate hike.

“[Wednesday’s] The intervention is designed to stabilize UK government bond prices, maintain bond market liquidity, and prevent financial instability, but this will not necessarily prevent sterling from falling further, with attendant inflationary consequences.

“I think there is still a good chance that they will need to act before the November meeting,” he added.

Julia Horowitz, Luke McGee, Anna Cuban, Rob North, Levi Doherty, and Morgan Buffy contributed to this article.

from San Jose News Bulletin https://sjnewsbulletin.com/the-uk-is-in-an-economic-crisis-of-its-own-making/