UK fiscal woes could worsen


The events of the past few weeks are not as dramatic as when the pound sterling was forced out of the European Exchange Rate Mechanism (ERM), but without the aggressive intervention of the Bank of England, the situation could have turned extremely bad.

Following the introduction of a mini budget with a package of tax cuts of around £45bn (€51bn), including a highly controversial measure to scrap the higher tax rate high of 45%, the financial markets reacted apoplectic and quite spectacularly.

Markets have essentially decided that Chancellor Kwasi Kwarteng’s unfunded tax cuts will lead to higher interest rates and a deterioration in public finances will undermine the UK’s long-term growth prospects.

Massive borrowing

The Institute for Fiscal Studies has warned that borrowing will reach £190bn (€216bn), which would be the third highest peak since World War II.

Following Kwarteng’s budget offer, the pound fell to an all-time low against the dollar and even lost a lot of ground against the euro, which is a currency that does not really have much of an advantage. for the moment. And government borrowing costs, or gilt yields, have soared across the yield curve.

The Bank of England was forced to intervene to lower long-term gilt yields by around 65 billion euros. This intervention was necessitated by the fact that market losses threatened the solvency of pension funds which were about to suffer massive margin calls that could have triggered a financial crisis of monumental proportions.

The relationship between 30-year gilt yields and the solvency of pension funds is extremely complicated, but suffice it to say that the central bank has recognized the grave peril resulting from market turmoil.

Following the budget, interest rate expectations have increased and the base interest rate is expected to rise to 5% or more in some quarters from 2.25% currently. This would translate into mortgage rates of at least 6%.

Although a high proportion of mortgages are fixed, some have predicted that many of these fixed rate mortgages will mature in the coming months. This does not bode well for the housing market or the economy as a whole.

Turmoil

The British economy and its political system are currently in turmoil. The heads of Prime Minister and Chancellor of the Exchequer are already in demand and Rishi Sunak’s political commitments, which have not pleased mainstream conservatives, look positively attractive to sane people.

The idea of ​​having such a massive, unfunded fiscal expansion plan, at a time when the Bank of England is raising interest rates in a bid to tame inflation, is bizarre beyond belief. .

Britain’s economy is the only G7 economy that’s even smaller than it was before the pandemic told us all we need to know.

Moreover, the decision to go ahead with Brexit has a fundamentally destructive impact on the UK economy.

irish concern

In Ireland, you can afford to look across the Irish Sea with amusement, but don’t get carried away. The UK accounted for almost 11% of Irish goods exports in the first seven months of this year and almost 38% of food and live animal exports.

The weakness of the pound sterling will hurt the competitiveness of these exports and will only aggravate the difficulties caused by Brexit. For British tourists, the weak pound will make Ireland less attractive, but at least the same will apply to our competitor countries in the Eurozone.

Economic performance and financial markets in the UK, including the British pound, are expected to remain extremely volatile, uncertain and weak for the foreseeable future. For Irish businesses with business interests in the UK, this will simply be an additional challenge in an already difficult and highly uncertain global business environment.

It should be mentioned that the Irish government announced a massive fiscal stimulus, but unlike the UK, it was funded by buoyant tax revenues and a budget surplus.

Jim Power is a leading Irish economic analyst

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