UK faces an economic crisis of its own making, analysts say

A week ago, the Bank of England raised interest rates by a relatively modest half a percentage point to fight inflation.

Less than 24 hours later, the government of new UK Prime Minister Liz Truss released its plan for the biggest tax cuts in 50 years, betting everything on economic growth but blowing a huge hole in the country’s finances and its credibility with investors.

The pound fell to a record low against the US dollar on Monday after UK Finance Minister Kwasi Kwarteng doubled down on his bet by suggesting further tax cuts without explaining how to pay them. .

Bond prices plummeted, driving up borrowing costs, wreaking havoc on the mortgage market and pushing pension funds to the brink of insolvency.

Financial markets were already in a feverish state due to the growing risk of a global recession and the swings caused by three US central bank rate hikes on the warpath against inflation.

In this “pressure cooker”, the new government of the United Kingdom stumbled.

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

After verbal assurances from the UK Treasury and the Bank of England failed to calm the panic – and the International Monetary Fund (IMF) delivered a rare rebuke – the UK central bank said it would print 65 billion pounds ($65 billion) 70 billion) to buy government bonds between now and October 14th — essentially shielding the economy from the fallout of Truss’ growth plan.

“While this is welcome, the fact that it needed to be done in the first place shows that UK markets are in a dangerous position,” said Paul Dales, chief UK economist at Capital Economics, commenting on the intervention. from the bank.

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.

The pound was down 1%, dropping below $1.08 on Thursday. UK government bonds were under pressure again, with the 10-year debt yield rising to 4.16%. UK stocks fell 2%.

“It wouldn’t be a big surprise if another problem in the financial markets were to arise soon,” Dales added.

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

“The Band-Aid can stop the bleeding, but the infection and the bleeding will get worse if they don’t do more,” he told CNN’s Julia Chatterley.

The Bank of England is expected to announce an emergency rate hike of a full percentage point ahead of its next scheduled meeting on 3 November. The UK government must 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 predicted continued announcements in the coming weeks about 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 in which it promised to publish a detailed report. . medium-term debt reduction plan.

‘Right plan’ or ‘reckless gamble’

But it shows no signs of backing down from the fundamental policy choice of borrowing heavily to finance tax cuts that will primarily benefit the wealthy at a time of high inflation. And the UK Treasury says it will not anticipate the November announcement.

Truss, speaking publicly for the first time since the crisis began, blamed global market turmoil and the energy price shock of Russia’s invasion of Ukraine for this week’s chaos.

“This is the right plan that we set out,” she told local radio on Thursday.

A major problem identified by investors, former central bankers and many top economists is that their government has only laid out half of a plan.

It followed 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.

He fired the top Treasury official earlier this month.

Charlie Bean, former Lieutenant Governor of the Bank of England, told CNN Business that the government was guilty of “really stupid” decisions.

His former bank boss Mark Carney accused the government of “harming” Britain’s economic institutions, saying it contributed to the “big blow” suffered by the country’s financial system this week.

“This is an economic crisis. It’s a crisis that policymakers can address if they choose to address it,” he told the BBC.

British newspapers have begun to speculate that Truss will have to fire Kwarteng, her close friend and political “soulmate”, if she is to regain political initiative and prevent her government’s dire poll ratings from falling further.

“All the problems we have now are self-inflicted. We look like reckless gamblers who only care about people who can afford to lose the bet,” a former Conservative minister told CNN .

“Raising, delaying or abandoning tax cuts will be avoided by Truss at all costs, as such a reversal would be humiliating and could leave her looking like a lame prime minister,” wrote Mujtaba Rahman and Jens Larson of political risk consultancy Eurasia Group. .

Increase in the emergency rate?

The only alternative left to balance the bills would be to cut government spending, and that would prove equally politically difficult as the country slips into recession with its public services under enormous pressure and a restless workforce that has shown it is ready to attack in large numbers pay.

“Truss and Kwarteng are now facing a severe economic crisis as the world’s financial markets expect them to make policy changes that they and the Conservative Party will find unpalatable,” the Eurasian analysts wrote.

The foreign investors who keep Britain’s economy solvent are left scratching their heads for another eight weeks, leaving plenty of time for doubts to arise again about the UK government’s commitment to responsible fiscal policymaking.

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

This leaves the Bank of England in a difficult position.

A week ago, it was putting the brakes on the economy to ease the heat of price increases, even as the government tried to spur growth.

The task became even more difficult this week, when he was forced to bail out the government. It may not be long before you have to intervene again, this time with an increased emergency rate.

“The intervention [de quarta-feira] It is designed to stabilize UK government bond prices, keep the bond market liquid and prevent financial instability, but this will not necessarily stop the pound sterling from falling further, with its inflationary consequences,” said Bean, a former sterling officer. central banker to CNN . The business.

“I think there’s still a good chance they need 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.