The United Kingdom is caught in an economic crisis of its own making

CNN business

A week ago, the Bank of England took a stab in the dark. It raised interest rates by a relatively modest half-percentage point to combat inflation. He could not know the magnitude of the storm that was about to explode.

Less than 24 hours later, the government of new UK Prime Minister Liz Truss unveiled a plan to make the biggest tax cuts in 50 years, boosting economic growth but blowing a big hole in the nation’s finances and credibility with investors.

The pound was lower against the US dollar on Monday after UK Finance Minister Kwasi Kwarteng doubled down on his bets, suggesting more tax cuts were to come without explaining how they should be paid for. Bond prices collapsed, borrowing costs soared, sparking a meltdown in the mortgage market and pushing pension funds to the brink of insolvency.

Financial markets were already at a fever pitch amid the growing risk of a global recession, fueled by a surge in the US central bank’s three biggest rate hikes on the warpath against inflation. The new UK government entered this “pressure cooker”.

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

When verbal assurances from the UK Treasury and the Bank of England failed to calm the panic – and the International Monetary Fund issued a rare rebuke – the UK central bank pulled out its bazooka, saying on Wednesday it would print 65 trillion pounds ($70 trillion). buying government bonds from today until October 14, essentially shielding the economy from the effects of Truss’s growth plan.

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

the kilo It fell 1%, falling below $1.08 early Thursday. UK bonds came under pressure again, with the yield on 10-year debt rising to 4.16%. UK shares fell 2%.

“It wouldn’t be a big surprise if another problem in the financial markets appeared before too long,” Dales added.

The next few weeks will be critical. Mohammed El-Erian, who once helped manage the world’s largest bond fund and now advises Allianz (ALIZF), said the central bank had bought some time but would again need to act quickly to restore stability.

“A Band-Aid can stop the bleeding, but the infection and the bleeding will get worse if they don’t stop it,” he told CNN’s Julia Chatterley.

The Bank of England is expected to announce an emergency rate hike of a full percentage point before its next meeting on November 3. The UK government should also delay 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 planned regular announcements in the coming weeks to change immigration policy and make it easier to build big infrastructure and energy projects to boost growth, culminating in the budget on 23 November. debt reduction plan medium term

But he shows no sign of backing away from the policy’s core choice of borrowing to finance tax cuts that will benefit the rich in 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 this week’s chaos on global market turmoil and a shock to energy prices following Russia’s invasion of Ukraine.

“This is the right plan we have come up with,” he said on local radio on Thursday.

A major problem identified by investors, central bankers and many leading economists is that his government only implemented half a plan at best. The country’s budget watchdog went ahead without an independent assessment of the £45 billion ($48 billion) annual tax cuts and assumptions about their longer-term impact on the economy. He fired a senior Treasury official earlier this month.

Charlie Bean, former deputy governor of the Bank of England, told CNN Business that the government was guilty of “really stupid” decisions. Mark Carney, his former boss at the bank, has accused the government of “damaging” the UK’s economic institutions, which he said contributed to the “huge blow” to the country’s financial system this week.

“This is an economic crisis. It’s a crisis … that policymakers can address if they decide to deal with it,” he told the BBC.

British newspapers are beginning to speculate that Truss will have to fire Kwarteng, his close friend and political soulmate, if he is to regain the political initiative and prevent his government’s dire poll ratings from sinking further.

“Every problem we have now is self-inflicted. They seem like irresponsible gamblers who only care about people who stand a chance of losing their bet,” a former Conservative minister told CNN.

But for now he’s trying to tough it out, and stick to the Reaganite experiment.

“Truss will avoid raising, delaying or abandoning tax cuts at all costs, as such a rollback would be humiliating and could leave him looking like a lame-duck prime minister,” wrote Mujtaba Rahman and Jens Larson at political risk consultancy Eurasia Group.

The only alternative left to balance the books would be to cut government spending, which would be politically difficult as the country plunges into recession with its public service under strain and a shrinking workforce that has shown itself ready for numerous strikes. pay

“Truss and Kwarteng are now facing a serious economic crisis as they wait for global financial markets to make policy changes that will be unpalatable to them and the Conservative Party,” Eurasia analysts wrote.

The foreign investors who keep Britain’s 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.

This leaves the Bank of England in a tight spot. A week ago he was pressing brakes on the economy to take the heat out of rising prices, even as the government tries to squeeze the juice out of growth. This week the task became even more difficult when the book of the crisis was dusted off and the government was forced to bail out.

It may not be long before we have 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 this will not necessarily stop sterling from falling further, with the attendant inflationary effects,” Bean, the central banker, told CNN Business.

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