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London
CNN Business
–
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 curb inflation. It could not know the scale of the storm that was about to break.
Less than 24 hours later, new UK Prime Minister Liz Truce’s government unveiled its plan for the biggest tax cut in 50 years, which is perfectly on track for economic growth but will blow a big hole in the country’s finances and its credibility with investors.
The pound crashed to a record low against the US dollar on Monday after UK Finance Minister Kwasi Kwarteng doubled-down on his bet to signal further tax cuts without explaining how to pay for them. Bond prices plummeted, borrowing costs soared, the mortgage market went into chaos and pension funds were pushed to the brink of bankruptcy.
Financial markets were already at a fever pitch due to the rising risk of a global recession and three outsized rate hikes by the US central bank on the way to a war on inflation. He stumbled into the new UK government in a “pressure cooker”.
“You need to have strong, reliable policies, and any policy mistakes are punished,” said Chris Turner, global head of markets at ING.
After verbal assurances by the UK Treasury and the Bank of England failed to calm panic – and the International Monetary Fund issued a rare rebuke – the UK central bank said on Wednesday it would print £65 billion ($70 billion). Buying government bonds between now and October 14 – essentially shields the economy from the fallout from the 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 precarious position,” said Paul Dales, chief UK economist at Capital Economics, commenting on the bank’s intervention.
Emergency first aid stopped the bleeding. Bond prices recovered sharply and the pound steadied against the dollar on Wednesday. But the wound has not healed.
pound It tumbled 1%, falling 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 in the financial markets were to emerge before long,” Dales added.
The next few weeks will be crucial. Mohamed El-Erian, who once helped run the world’s largest bond fund and now advises Allianz (ALIZF), said the central bank had bought some time but would need to act quickly again to restore stability.
“Band-aids can stop the bleeding, but if they don’t do more the infection and the bleeding will get worse,” he told CNN’s Julia Chatterley.
The Bank of England must announce an emergency rate hike of a full percentage point before its next scheduled meeting on November 3. The UK government should also postpone its tax cuts, El-Erian said.
“It is possible, the window is there, but if they wait too long, that window will close,” he added.
The UK government has previewed rolling 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 November 23 in which it promised to detail was given Debt reduction plan In the medium term.
But it shows no signs of moving away from the basic policy choice of borrowing heavily to fund tax cuts that will primarily benefit the rich at a time of high inflation. And the UK Treasury says it will not bring forward the November announcement.
Truss, speaking publicly for the first time since the crisis erupted, blamed global market turmoil and shocks to energy prices from Russia’s invasion of Ukraine for this week’s chaos.
“This is the right plan that we have set up,” she told local radio on Thursday.
A major problem identified by investors, former central bankers and many leading economists is that their government has only half-planned 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. He sacked a top Treasury civil servant earlier this month.
Charlie Bean, a former deputy governor of the Bank of England, told CNN Business that the government was guilty of “really stupid” decisions. His former boss at the bank, Mark Carney, accused the government of “undercutting” the UK’s financial institutions, saying that this week contributed to the “major knock” suffered by the country’s financial system.
“This is an economic crisis. It is a crisis… it can be addressed by policymakers 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 ally, if she is to regain the political initiative and prevent her government’s dire poll ratings from falling further.
“Every single problem we have now is self-inflicted. We look like mindless gamblers who only care about people who can lose at the gamble,” one former Conservative minister told CNN.
But for now she’s trying to tough it out, and sticking to the Regnite experiment.
“Truss will avoid extending, postponing or abandoning tax cuts at all costs as such a reversal would be humiliating and could make her look like a lame duck prime minister,” wrote Mujtaba Rahman and Jens Larsen at the political risk consultancy Eurasia Group.
The only option to balance the books will be to cut government spending, and that will prove equally difficult politically as the country enters recession with its public services under enormous strain and a restive workforce that shows it is poised for mass strikes. . payment
“Truss and Kwarteng now face a serious economic crisis as world financial markets wait for their policy changes that would be unpopular with them and the Conservative Party,” Eurasia analysts wrote.
Foreign investors who have kept the British economy solvent are left scratching their heads for another eight weeks, leaving plenty of time for doubts about the UK government’s commitment to responsible fiscal policymaking.
“The message from the financial markets is that in this environment unfunded spending and unfunded tax cuts are limited and cost much more than borrowing costs,” Carney said.
That leaves the Bank of England in a tight spot. A week ago he was pressing The economy has taken a break from the heat of price hikes, even as the government tried to boost growth. The task became more difficult this week when he was forced to dust off his crisis playbook and bail out the government.
It may not 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 volatility but will not necessarily prevent sterling from falling further, with its attendant inflationary consequences,” Bean, a former central banker, told CNN Business.
“I think there’s still a good chance they’ll need to act before the November meeting,” he added.
— Julia Horowitz, Luke McGee, Anna Kuban, Rob North, Livy Doherty and Morgan Povey contributed to this article.
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