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Market Meltdown Sends a Warning to UK Government

Kwasi Kwarteng, UK chancellor of exchequer, departs 11 Downing Street to present the UK’s fiscal plans in Parliament, in London, UK, on Friday, Sept. 23, 2022. With expectations of tax cuts and sweeping deregulation, businesses are likely to be a big beneficiary of Kwarteng’s mini-budget on Friday. (Bloomberg)

The UK government’s ginormous fiscal boost sets the scene for a painful battle between a Treasury charged by its political masters with boosting growth and the Bank of England’s determination to curb an inflation rate that’s already running about five times higher than its target. With fiscal and monetary policy starting to pull in opposite directions, it’s essential that central bank independence remains inviolable.

The tax cuts announced by Chancellor of the Exchequer Kwasi Kwarteng Friday — covering everything from the highest-paid employees to alcohol to housing to companies — are designed to increase spending and investment to propel economic growth to an annual pace of 2.5%, a level Britain hasn’t achieved for a decade. The total cost of the package in the next five years will be more than £160 billion ($177 billion).  

Based on the market reaction, the plan is completely, totally, utterly unaffordable. The pound dropped below $1.11 in the wake of the announcement, a level not seen since March 1985. Parity with the dollar beckons. Government borrowing costs in the gilt market soared, with five-year yields jumping 50 basis points and headed for their biggest climb ever; the additional £60 billion of annual debt sales needed to fund the largesse will cost dearly.

For the UK central bank, the government’s 180-degree switch to shaking the magic money tree hard after post-pandemic parsimony makes its job even harder. The country is already probably in recession; with inflation already at its fastest pace in almost 40 years, the government’s pump-priming risks driving consumer prices even higher than the 11% peak the BOE forecast on Thursday.

The Monetary Policy Committee voted yesterday by 5-to-4 to increase the official interest rate by half a point to 2.25%. It’s a fair bet that if the central bank had been given advance notice of the scale of the largesse being dished out, more than three of the nine policy makers would have voted in favor of a 75 basis-point hike.

Instead, they’re likely to accelerate the pace and scale of borrowing-cost increases. The futures market is now anticipating a 50% chance that rates will rise by a full percentage point at the next monetary policy meeting in November; the benchmark rate is now expected to reach 5.25% by the middle of next year, 100 basis points higher than traders were anticipating at the start of this month.

So a painful tug-of-war between fiscal and monetary policy is looming. “We’re in an uncomfortable position,” BOE committee member Jonathan Haskel said late Thursday. Friday’s violent market reaction should serve notice to the government that its recent hints about amending the central bank’s remit will end very, very badly if it’s perceived to be eroding BOE independence.

More From  Bloomberg Opinion:

Give Bankers Bigger Bonuses? The UK Is Playing With Fire: Marcus Ashworth

Britain Goes the Wrong Way on Energy Bailout: Javier Blas

Is Kwasi Kwarteng Up for Saving Britain’s Economy?: Adrian Wooldridge

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. A former London bureau chief for Bloomberg News, he is author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

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