from Cameron's ill-considered Brexit referendum, to May's inability to gain consensus to Johnson's failed Brexit and pandemic policies and now Truss' irresponsible fiscal tax cuts....undeniably, the Conservatives failed Britain and have accelerated the country's long term structural decline ...
the Brits are in for a tough time,..lower purchasing power from a historic low pound and higher mortgage costs alongside double digit inflation....
The UK’s Crisis of Confidence Was Years in the Making
The UK thought it had the trust of markets — until it didn’t. Now homeowners and businesses will likely have to pay the price.
By
Philip Aldrick,
Libby Cherry, and
David Goodman
September 29, 2022 at 9:00 AM GMT+10
Britain is in a self-inflicted financial crisis that threatens to accelerate the economy’s dive into recession — and the country’s new prime minister is coming under intense pressure to blink.
In the week since the government unveiled the biggest tax cuts since 1972 with scant detail of how they will be financed, the pound has crashed to its lowest-ever level against the dollar, the cost of insuring British government debt against the risk of default has soared to the highest since 2016, and the Bank of England has been forced to intervene amid concerns about the nation’s pension funds.
What happens next will determine just how deep the looming recession proves. Central to that question is whether Liz Truss’s three-week old administration can restore its credibility with investors.
Gloomy September
The value of UK assets has tumbled since Liz Truss became prime minister
Source: Bloomberg
Normalized as of September 5
Friday’s mini-budget has become a flashpoint for not just investors’ short-term concerns about unfunded tax cuts at a time when inflation is running close to a four-decade high, or the Bank of England’s failure to contain price growth. It has given sharp focus to their long-held fears about Britain, its current-account deficit, its fractious relationship with its closest trading partner and, above all, a mistrust of what successive politicians promise.
“It’s the latest in a long line of self-imposed economically illiterate decisions,” said Peter Kinsella, global head of FX strategy at Union Bancaire Privee UBP SA in London. “It started with Brexit, and now we’re seeing the latest iteration.”
As markets tumbled, the Bank of England was forced into action to prevent a gilt market crash — and deployed a variant of a policy tool Truss spent recent months criticizing. It promised to buy whatever long-dated gilts were needed to restore order to the market. That set off a rally in long-dated gilts — but increases two risks: that the bank will have to raise rates even further within weeks, and that investors could take fright at whether the BOE is bankrolling the government.
BOE Action
Long-dated yields posted a record fall after the central bank intervened
Source: Bloomberg
For now, though, the BOE has bought the “government time to fix its credibility,” according to Kallum Pickering, senior economist at Berenberg Bank.
How they use that time will be crucial. Top bankers in the City of London yesterday urged Chancellor of the Exchequer Kwasi Kwarteng to reassure markets before a planned statement on Nov. 23. Truss, who hasn’t appeared in public since Friday, is preparing for her first speech to the Conservative Party conference as prime minister next week.
The International Monetary Fund, which came to the UK’s rescue in 1976, has already urged the government to reconsider its tax cuts. Famed economists are lining up to warn the UK is displaying the hallmarks of an emerging market.
The problem for Truss is that she made the tax cuts the centerpiece of her program for government. An about-turn so early into her tenure would be politically fatal: She only won office thanks to the backing of grassroots party members. Most MPs in her own party voted against her, leaving her exposed to a backlash if they sense her policies will lead to defeat.
While Britons wait to see if her gamble on “trickle-down” economics pays off, they face a dramatic increase in borrowing costs — something that could trigger a housing crash and deepen any recession — or a round of swingeing public spending cuts.
“Between Brexit, how far the Bank of England got behind the curve and now these fiscal policies, I think Britain will be remembered for having pursued the worst macroeconomic policies of any major country in a long time,” said former US Treasury Secretary Lawrence Summers, now a professor at Harvard University and paid contributor to Bloomberg Television.
The Treasury declined to comment for this story.
The crisis of confidence had been brewing for years. Dubious claims from the ruling Conservatives — ranging from Brexit’s benefits to parties in Downing Street during lockdown — together with the recent ousting of the Treasury’s top official and the side-lining of the country’s budget watchdog meant investors didn’t believe the Chancellor when he promised to stabilize the public finances.
The markets “aren’t willing to trust the Truss administration’s claims that it will deliver medium-term fiscal sustainability on the basis of its word alone,” said Allan Monks, an economist at JPMorgan Chase & Co. in London. “That reflects a broader distrust in markets about how UK policy making has been evolving — and in our view, that distrust is entirely justified.”
Nothing illustrates it better than the slide in the pound. It’s fallen from a high of more than $2 in 2007, just before the financial crisis, to $1.50 at the time of the Brexit referendum, and is now on the brink of parity with the dollar.
A Century of Decline for the British Pound
Sterling reached a record low in the wake of the government's fiscal plan
Source: BOE, Bloomberg
“Because the UK has damaged its once strong credibility with a poorly managed Brexit and persistent threats of a UK-EU trade war, it no longer enjoys the benefit of the doubt,” said Berenberg’s Pickering.
For JPMorgan’s Monks, the doubts set in before the 2016 Brexit referendum, accelerated after the shock result, and culminated in recent attacks on the central bank, the judiciary, and the civil service.
That background of mistrust may have obscured some of the mini-budget’s beneficial reforms. Simon French, chief economist at Panmure Gordon & Co., said the mishandling of the mini-budget was “a shame” because several of the supply-side reforms in areas like planning “have real merit.”
Historic Giveaway
Kwarteng's tax cuts are the largest since Anthony Barber was chancellor
Source: Bloomberg analysis of OBR, Treasury data
Note: Figures show the five largest tax giveaways and the five largest tax-raisers since 1970
Nevertheless, Friday’s act of fiscal largess — being unfunded — marked a major break from the economic traditions of Truss’s Conservative Party. The government still needs to set out how it will cover the additional borrowing required to fund its £45 billion of tax cuts and further £60 billion-plus for its program to offset the recent surge in energy bills.
Those measures will drive up the country’s budget deficit to 4.5% of gross domestic product. That would be enough to put the debt burden on an explosive path, hitting 101% of GDP by 2030, according to Bloomberg Economics.
In the meantime, the Bank of England will come under mounting pressure. The central bank has spent much of the year struggling to raise interest rates fast enough to combat a surge in inflation it failed to predict.
The BOE is now all but guaranteed to respond to the looser fiscal policy with tighter monetary policy. Money market traders are now betting on at least a 150 basis-point rise in interest rates by policymakers' next gathering on Nov. 3. Setting aside the risk of an emergency hike outside of scheduled meetings, that would be a move unprecedented since the bank was granted independence by the government in 1997. Pricing also shows the benchmark rate will almost certainly hit 6% next year.
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