Since the UK government unveiled the biggest tax cut since 1972 (with few details on how they plan to finance it), the pound has tumbled to its lowest level against the dollar and the cost of insuring debt has risen. rocketed to the highest level since 2016, with the Bank of England being forced to intervene on fears around pension funds. The country is on the precipice of a major financial crisis that threatens to accelerate a recession. And of course, homeowners and businesses are going to be the ones who end up paying the price.
Less taxes, more debt. The decision of the Prime Minister, Liz Truss, to apply the biggest tax cut in 50 years and cover it with loans just at a time of great inflation (its highest in four decades) has shaken the markets. And it has raised concerns among the world’s economists, who basically argue that fiscal policy should not work against monetary policy. These measures will raise the country’s budget deficit to 4.5% of GDP in the medium term, according to Bloomberg, putting the debt burden on a cumbersome path.
How will it be financed, everyone’s doubt. The Government’s plan, ambitious as it may be, wants to annul the last rise in corporate tax, unstop bonuses for high-ranking bankers and a downward reform of income tax. This “act of fiscal generosity”, without funds, has many doubts. Mainly, the government has yet to answer how it will cover loans to finance cuts of 45 billion pounds and more than 60 billion more for its program to offset the recent rise in energy bills.
The Bank of England to the rescue. The institution has been forced to launch an emergency intervention to try to stabilize the financial markets and stop the fall of the pound. It has announced that it will buy long-term bonds, expected until October 14. “Acquisitions will occur in an orderly and smooth manner, until the risks to the functioning of the market are deemed to have subsided,” he warned.
They do so because if the situation in this market worsened, there would be a significant risk for the financial stability of the country and given its clear volatility, whose profitability has gone from 3.84% to 4.43% in just two days. In addition, as a defense against the increasing risk that other sectors will be infected, such as a possible increase in mortgage prices that already affects households and companies.
Crisis in the real estate market. Meanwhile, Britons face rising borrowing costs, something that could trigger a housing crisis and deepen a recession. Among other effects, the fall in the pound and the increase in interest rates could cause a fall in house prices of 10% to 15%, in contrast to the imminent rise in mortgages. Analysts are already warning that it would be a real estate collapse comparable to that of the 2008 crisis.
“We don’t know yet, but if rates go up to 6% or 7% in the middle of the cost of living crisis, the situation would be disastrous. We are facing a real risk of people losing their jobs and then their houses,” warned Neal Hudson, an analyst at BuiltPlace in this Fortune article. The first consequences are already being observed: the mortgage panic has led to a withdrawal by the big banks, which have withdrawn more than 360 low-interest financial products from the market, fearing a new increase in rates.
The IMF’s ear spurt. The International Monetary Fund, which we remember came to the UK’s rescue in 1976, has already called on the government to reconsider its tax cuts. In the first place, it considers that the measure is inadequate in the current inflationary situation in which we find ourselves and, secondly, it maintains that “it will probably increase inequality” by favoring the rich.
For this reason, it recommends the British Government “weigh ways to provide more specific support and re-evaluate fiscal measures, especially those that benefit people with high incomes”. However, his economy minister, Kwasi Kwarteng, defends his growth strategy, based on lowering taxes, especially on the rich and companies. The reason lies in the party’s change of course, which believes that it is right to consider that the recession is a greater evil than inflation and accuses the IMF of promoting too conventional policies.
Image: GTRES