Britain’s Spending and Tax Cut Plans Worry Investors in Its Debt

In the UK, 10 days of nationwide mourning leading up to Queen Elizabeth’s state funeral will bring many of the government’s outbound business to a halt as schools, clinics and many shops are closed. I’m here.

But all the while, financial markets have been complaining about worries about the UK’s economic outlook.

High inflation and low economic growth are expected to continue, compounded by huge borrowings to fund the new government’s plan to freeze energy prices while cutting taxes. There are still uncertainties about the financial plans of Liz Truss, who became prime minister just two days before the Queen’s death, and investors are worried that trade ties with Britain’s biggest commercial partner, the European Union, will continue to grow in the wake of Brexit. He continues to fear that it may collapse in less than two years after becoming law.

Again, British assets are not in favor. Bonds, stocks and the pound have fallen simultaneously in recent weeks. This is an unusual and ominous confluence that could set the stage for rising borrowing costs and stubborn inflation.

“The prime minister has a lot to do to reassure markets,” said Jane Foley, senior currency strategist at Rabobank in London. “The market is not convinced that her policies will improve the investment climate in the UK,” she said.

Even in a difficult year for markets around the world, weakness in UK assets was noticeable. The pound has fallen about 15% against the US dollar this year, reaching its lowest level since 1985 last week, but against the euro it has fallen more than 3%. His FTSE 250, a stock index that includes the majority of domestically-focused companies, is down almost 20% this year. Also, falling bond prices have pushed the 10-year yield above his 3%, his highest in 11 years. In August alone, 10-year yields rose nearly 1 percentage point, the biggest monthly gain on Bloomberg’s record since 1989.

On his third day in office, Truss unveiled a major plan to freeze home energy bills and provide ‘equal’ support to businesses in Congress as nearly double-digit inflation deepens the cost of living crisis. Did. next six months. What was clearly lacking was an official estimate of how much it would cost.

“The truss package on the energy bill was big enough to pass the political test, but it has not yet passed the economic test,” said Mujitaba Rahman, director of the Eurasia Group. I’m writing. He described the policy as “a blank check financed by more borrowing.”

The policy could cost around £150 billion ($172 billion), according to Paul Johnson, director of the Institute for Fiscal Studies, a London-based bipartisan think tank.

“It could be the biggest single financial announcement in peacetime,” he said. Calling it a “staggering sum,” he added that the government made a mistake not to publish an estimate of the cost.

The government is also widely expected to announce a series of tax cuts this month, which Mr Truss promised in this summer’s Conservative leadership election. It could have a bigger impact on Britain’s finances than a temporary freeze, he said. The government will also need to raise more money for public services such as the National Health Service and teacher salary increases as inflation has eroded the value of previously announced spending plans, he added. .

“There is a more general question about the large fiscal expansion likely this year in a time of very high inflation,” Johnson said.

The problem of rising borrowing costs is underscored by the Bank of England’s efforts to end the era of easy money by slashing the highest inflation in 40 years. Central banks have abandoned the practice of buying large amounts of bonds. The policy helped bring down interest rates when the government borrowed hundreds of billions of pounds to pay for health care and hundreds of billions to keep and support people’s jobs. business. The bank is preparing to make the equivalent of a U-turn, selling the bond back to the market.

Buying new debt will be left to individual investors. The Treasury’s recent auction of UK government bonds shows healthy demand for bonds, but the central bank’s sale of bonds is uncharted territory.

Sue Nofke, head of UK equities at Schroders, said that while UK equities have suffered since Brexit, more uncertainty and fears over economic growth and political turmoil have pushed investors away from equities. said it had become “one of the first countries to be dumped”.

Betting against the pound has increased recently. Analysts have warned of vulnerability to a sharp decline as the UK’s current account deficit widens. A deficit means that the value of imported goods and services exceeds the value of UK exports and other income from foreign investment. With energy prices so high, that gap is expected to continue to widen. In the first quarter of this year, she hit a record high of 8.3% of gross domestic product.

The UK’s budget deficit and current account deficit means it needs to borrow, which makes it more reliant on what Mark Carney, the former governor of the Bank of England, called “the kindness of strangers.” I’m here.

Deutsche Bank strategist Shreyas Gopal warned in a report just before Mr. Truss took office on Sept. 6 that his kindness, or investor trust, “cannot be taken for granted.” Without it, Britain would be in trouble. .

In an analyst note, Gopal wrote that “a very large but untargeted spending package” risks exacerbating investor concerns about the sustainability of the deficit. “If investor confidence is further eroded, this dynamic could become a self-contained balance of payments crisis in which foreigners refuse to fund the UK’s external deficit,” he wrote.

This “may sound extreme, but it’s not unprecedented,” Gopal added. He noted that in the mid-1970s, “a combination of aggressive fiscal spending, a severe energy shock, and the depreciation of the pound” forced Britain to seek $4 billion in loans from the International Monetary Fund.

For some, remembering the 1976 financial crisis is a step ahead. Analysts at Barclays dismissed the “hoaxes” surrounding the balance of payments crisis, saying the real risk to the currency instead lies in worsening trade between the UK and the European Union.

But concerns are widespread.

Richard Portes, an economics professor at the London Business School, said the UK’s economic background was “deeply disturbing”, citing a large current account deficit, labor unrest and the Truss government’s decisions. did. dismiss top Treasury officials and the possibility of recession.

“The system’s current capacity to deal with a crisis is not very strong,” Ports said. “The Governor of the Bank of England is in a very weak position politically. The Treasury has no head. Where are the adults?”

Few expect a 1976 re-enactment, but some similarities cannot be ignored.

“What worries me is that while there are radical moves towards growth, such as tax cuts and spending increases, the year leading up to the election may look good, but it is highly unsustainable. , can be potentially damaging in the long run. Johnson, Institute of Fiscal Studies.

Truss and Finance Minister Kwasi Kwarteng said they aim for 2.5% economic growth.

However, it may be difficult to reach that goal immediately. Analysts say the economy could plunge into recession this quarter as a special holiday for the Queen’s state funeral will bring many businesses and public services to a halt. The size of the economy has changed little this year, with the Bank of England last month predicting that next year it will shrink by 1.5%.

“Until we find ways to boost productivity, we will face several years of slower growth and higher inflation,” he said. Rabobank’s Foley said: “Given Brexit and the energy crisis we are facing, it is clear that it will not be a quick solution.”

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