Ten shocking days for the UK by Mohamed A. El-Erian
Recent policy decisions in the UK have jeopardized the country’s economic well-being and financial stability, with the most vulnerable segments of the population facing the greatest risks. But with quick and coordinated action, policymakers can still change course.
CAMBRIDGE — The UK has spent ten days pondering as its economy, financial system and the well-being of its citizens suddenly come under threat. But with quick and coordinated action, policymakers can still save the day.
Last Friday, ratings agency Standard & Poor’s placed the UK’s AA credit rating on ‘negative watch’ – effectively threatening the country with a downgrade – fearing that the package of unfunded tax cuts proposed by the new government (the “mini-budget”) increase the country’s debt burden. A downgrade would become more likely if “economic growth turns out to be weaker due to a further deterioration in the economic environment or if government borrowing costs increase more than expected, driven by market forces and monetary policy tightening”.
Although S&P’s rating action will not materially affect the UK’s access to credit, it represented another embarrassment – with extraordinary volatility in borrowing costs and a reprimand from the International Monetary Fund – for the government. of Prime Minister Liz Truss. It further undermines three pillars of UK well-being: the credibility of policy-making, economic performance and the integrity of financial markets.
S&P’s decision was far from the only consequence of Chancellor Kwasi Kwarteng’s September 23 announcement of the mini-budget. The plan spooked financial markets and triggered a precipitous drop in the value of the pound, as it signaled that Kwarteng would pressure the stimulus accelerator, even as the Bank of England brakes. In fact, just two days earlier, the BOE had decided to raise the key rate from 1.75% to 2.25% – the highest level since the global financial crisis of 2008 – and announced further hikes to come. .
Deepening the political contradiction, the BOE’s chief economist warned days later that the government’s plan would require a “significant monetary response”. But the very next day, September 28, the BOE was forced to announce a two-week program to buy £65 billion ($73 billion) of long-term bonds, in order to restore financial stability and avoid a collapse of the pension sector.
The threat of a crash in the financial markets has therefore considerably complicated the BOE’s already delicate task of finding the right balance between fighting inflation and minimizing damage to economic activity. Financial stability was suddenly also at stake. Undermining the UK’s political credibility even further, the government attempted to circumvent the established institutional framework as it advanced its budget measures, including failing to consult adequately with the Office of Budgetary Responsibility (OBR) and other agencies.
PS Events: Investing in health for all
Our virtual event, Investing in health for all, began. Tune in now to watch live as world leaders and global experts – including Tedros Adhanom Ghebreyesus, Werner Hoyer, Sandra Gallina and Marie-Ange Saraka-Yao – discuss the lessons that the COVID-19 pandemic and other recent crises offer to meet the public- health challenges of the years to come.
The negative consequences for the economy immediately began to be felt in the housing finance market – an important sector not only economically, but also socially and psychologically. A spike in the cost of mortgages has been accompanied by a disruption in their availability. Adding to the October 1 energy and gasoline price hikes, this is sure to further erode business and household confidence, despite measures to prevent further oil price hikes. energy for a while.
The wild swings that gripped UK financial markets for three days after the announcement of the mini budget were unthinkable to many a day earlier. Yet they pale in comparison to the BOE intervention on September 28th.
Even in emergency mode, central banks prefer to wait until the weekend or, at the very least, until the end of the trading session, before taking a hard political decision. This allows them to frame the political decision and provide contextual information, thereby mitigating dramatic market overreactions.
That apparently was not possible for the BOE, which announced its bond-buying program at 11 a.m. on a Wednesday. The immediate dislocation of the pensions sector, along with fears of disruptive spillovers to other parts of the financial sector and the real economy, necessitated a bold and historic move by the BOE.
The bad news is obvious: Britain’s economic well-being and financial stability are at risk. If policymakers continue on this path, the most vulnerable segments of the population – who are already bearing the brunt of the crisis in the cost of living, income insecurity and rising borrowing costs – will suffer the more.
The good news is that the situation can be corrected. To this end, the government should bring forward the publication of the next OBR forecast (scheduled for November 23), taking this opportunity to postpone its unfunded tax cuts and provide stronger analytical content to its recovery plan. growth and getting stronger institutional support for it. The government should avoid spending cuts that would undermine the country’s growth potential and harm public services. For its part, the BOE’s Monetary Policy Committee should meet before the next scheduled date (November 3) and raise interest rates.
These two steps must be accompanied by targeted measures to protect the most vulnerable segments of the population, as well as a strengthening of the prudential supervision of the non-banking sector and better coordination of global policies, which should be pursued in partnership privileged with the United States. To alleviate concerns about the political costs of large mini-budget adjustments, this course correction can be presented as a response to external market instability, which is abundant, and evidence that the global economy is slowing down. faster than expected.
After ten difficult and shocking days, UK policymakers have a chance to reset themselves. Failure to grasp it will exacerbate current economic, political and financial imbalances and will require more costly and complicated adjustment over time.