The humiliation of the British authorities is complete. After five days of financial panic, caused by a poorly received British budget, an initial statement by the Bank of England (BoE) that had no effect, and a rebuke by the International Monetary Fund (IMF), it was necessary to bring out the big guns. On Wednesday, September 28, the Bank of England announced that it was intervening in the financial markets by buying long-dated UK government bonds "on whatever scale is necessary." "Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability," it explained in a statement.
The intervention had the desired effect. The bond market eased, with the 10-year UK bond rate falling from 4.6% to 4%. Sterling stabilized at 1.07 to the US dollar, slightly above its all-time low of 1.035 on Monday.
Significant tax cuts
The turmoil was started by Kwasi Kwarteng, the new Chancellor of the Exchequer, when he presented a British "mini-budget" on Friday, September 23. He announced the largest tax cuts in 50 years, amounting to 1.5% of GDP. Added to this is a freeze on gas and electricity bills for households and businesses. "This will increase the public deficit to 7% in 2023," rating agency Scope Ratings calculated. But Mr. Kwarteng said nothing about how he would finance this, delaying a full presentation of the cost of his plan and his economic forecasts until November 23.
Prime Minister Liz Truss told local radio on Thursday, "We had to take urgent action to get our economy growing, get Britain moving, and also deal with inflation. [...] And of course, that means taking controversial and difficult decisions, but I'm prepared to do that as prime minister."
"This budget was nonsense," said Mathieu Savary, a strategy specialist at BCA Research, an investment research firm. He argued that tax cuts in the middle of an inflationary period will only make prices go up faster. "It's been six years of the UK making one blunder after another since Brexit," Savary continued. "Today, the markets don't trust the UK, they see it as less credible than before."
The Bank of England will have to raise its interest rate more than expected. Markets are now expecting a rise of 6%
In this setting, the presentation of the mini-budget caused initial concern on the markets. Then, on Sunday, September 25, instead of trying to reassure them, Mr. Kwarteng doubled down, promising in an interview with the BBC that "more [tax cuts] are coming." When markets reopened on Monday, their judgement was annihilating. The pound sterling fell to the lowest level against the dollar in its multi-century history. More seriously, the rate on British bonds soared, approaching the level of Italian bonds, themselves under great pressure.
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