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The UK is hit by an economic crisis of its own making | CNN Business

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A week ago, the Bank of England took a stab in the dark. It’s high interest rates relatively modest half a percentage point to deal with inflation. She could not know the scale of the storm that was about to break.

Less than 24 hours later, the government again UK Prime Minister Liz Truss unveiled his plan for the biggest tax cuts in 50 years, doing all he can for economic growth but blowing a big hole in the nation’s finances and his credibility with investors.

The pound crashed to a record low against the US dollar on Monday after UK finance minister Kwasi Kwarteng doubled down by hinting at more tax cuts to come without explaining how to pay for them. Bond prices collapsed, raising borrowing costs, causing chaos in the mortgage market and bring 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 gyrations caused by three outsized rate hikes from a US central bank on a war footing against inflation. In this “pressure cooker” the new government of the United Kingdom stumbled.

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

After verbal guarantees by the UK Treasury and the Bank of England failed to quell the panic, and the International Monetary Fund delivered a rare rebuke – the United Kingdom the central bank took out its bazookasaying on Wednesday that it would print £65 billion ($70 billion) to buy government bonds between now and Oct. 14, essentially shielding the economy from the fallout from Truss’s growth plan.

“While this is welcome, the fact that it needs 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 against the dollar on Wednesday. But the wound has not healed.

The pound fell 1%, dipping back below $1.08 early on Thursday. UK government bonds came under pressure again, with the 10-year debt yield rising to 4.16%. UK stocks fell 2%.

“It wouldn’t be a huge surprise if another problem were to emerge in the financial markets any time soon,” Dales added.

The next few weeks will be critical. Mohamed El-Erian, who once helped run the world’s largest bond fund and now advises Allianz

he said the central bank had bought some time but would have to act again quickly to restore stability.

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

The Bank of England is due to announce an emergency rate hike of a full percentage point before its next meeting scheduled for November 3rd. The UK government should also postpone 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 has anticipated continued announcements in the coming weeks about how it plans to change immigration policy and ease the construction of major infrastructure and energy projects to boost growth, culminating in a budget on November 23 in which it promised publish a detailed report. debt reduction plan in the medium term.

But it shows no signs of backing away from the pivotal policy choice of going into deep debt to finance tax cuts that mainly benefits 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 the shock to energy prices from the Russian invasion of Ukraine for this week’s chaos.

“This is the correct plan that we have put in place,” he told local radio on Thursday.

A big problem identified by investors, former central bankers and many leading economists is that his government only put in place half a plan at best. It went ahead without an independent assessment by the country’s budget watchdog of the assumptions underlying the £45bn ($48bn) annual tax cuts and their long-term impact on the economy. He fired the top Treasury official 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 “undermining” Britain’s economic institutions and said that had contributed to the “major blow” to the country’s financial system this week.

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

British newspapers have begun to speculate that Truss will have to fire Kwartengyour close friend and political soulmate, if you want to regain the political initiative and prevent your government’s dire poll ratings from plummeting further.

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

But for now she is trying to resist and hold on to the reaganite experiment.

“Truss will at all costs avoid increasing, postponing or abandoning tax cuts, as such a reversal would be humiliating and could leave her a lame prime minister,” Mujtaba Rahman and Jens Larson wrote at political risk consultancy Eurasia Group.

The only alternative left to balance the books would be to slash public spending, and that would prove just as difficult politically as the country enters a recession with its public services under enormous pressure and a restless workforce that has shown that it is ready to strike in large numbers for pay.

“Truss and Kwarteng now face 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 Eurasia analysts wrote.

Foreign investors keeping 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 policy to resurface.

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

That leaves the Bank of England in a difficult situation. A week ago I was pressing the brakes on the economy to relieve the heat of price increases, even as the government tried to stimulate growth. The task became even 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 he 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 instability, but that will not necessarily prevent sterling from falling further, with its attendant inflationary consequences,” he said. Bean, a former central banker, told CNN Business.

“I think there is still a good chance that they will 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.

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