Upon arriving in Downing Street, Truss said he would “weather out the storm” and promised help with energy bills and tax cuts. If her government borrows too much, it risks further accelerating inflation and increasing fears among investors that the country’s finances are deteriorating. unsustainable.
That could cause the pound to plummet, making prices even higher and making it harder to pay for essential imports.
Not so long ago, this kind of scenario would have sounded like an outlandish topic.But as Truss teases There is talk of a massive energy bailout package and tax cuts, and the pound continues to stagnate near multi-decade lows. Some analysts warn that a “balance of payments” crisis cannot be ruled out.
Deutsche Bank strategist Shreyas Gopal wrote in a note to clients titled “The Crisis for the Pound”: “Ultimately, it remains to be seen whether these risks materialize in the coming weeks and months. “It depends on the credibility of the new government’s policies in the moon,” he said.
What is a balance of payments crisis?
If they lose confidence, turmoil in the financial system could quickly snowball. When traders dump the national currency, its value plummets, causing inflation and forcing the central bank to raise interest rates even more to control the situation. That could exacerbate recession conditions, so the spiral continues.
But the UK has precedents. When the pound rapidly lost value against the US dollar in the mid-1970s, the country was forced to demand her $3.9 billion from the IMF, he noted. At the time, it was the largest amount ever requested.
The pound is now in danger again. On Monday, it fell briefly to around $1.14, its lowest level since 1985. This is even worse than the euro, which fell less than 13%. Borrowing costs for the British government have also risen sharply as investors sell off government bonds.
Investors are fleeing UK assets due to economic concerns. UK inflation is the highest in her G7 and could rise further next year if natural gas prices continue to rise. The Bank of England has been raising interest rates since December last year and may be compelled to take even more aggressive action.
“British assets are very unloved at the moment,” said Paul O’Connor, head of Janus Henderson’s UK-based multi-asset team. We are facing a serious cost of living crisis and significant political uncertainty surrounding it.”
According to Gopal, this is a big problem for the UK. Because the UK has a record current account deficit. That means the UK spends more on goods, services and investments abroad than it does at home. Years of low growth and a blow to trade after Brexit have not helped.
“The pound needs massive capital inflows, supported by improved investor confidence and lower inflation expectations,” Gopal wrote. “But the opposite is happening.”
Britain is not Argentina, but…
The currency edged higher on Tuesday as Truss officially started his term as prime minister.
Investors were encouraged by early reports about her plans to address the energy crisis. This is expected to be announced this week. She will announce an energy bill cap by borrowing £100 billion ($115 billion). This would exceed her €95 billion ($94 billion) pledged by the German government to tackle similar problems.
“Investors see this as a pretty definitive way to mitigate recession risks in the UK,” O’Connor said.
But questions resurface about how she plans to pay for that bailout package and other campaign promises, such as increasing defense spending and rescinding proposed business and payroll tax increases. There is a possibility.
Former UK Finance Minister Ken Clarke told the BBC on Tuesday: “If there is a real financial crisis and it accelerates, the sterling going down is a real and serious problem for real people. is critical of Truss’ tax cut plan, which she argues will help fund increased spending by boosting economic growth.
Viraj Patel, Global Macro Strategist at Vanda Research, believes the concerns are exaggerated. He places his odds of a balance of payments crisis in the UK at less than 5%.
“A lot has to go wrong to get to this point, and I would imagine the UK government to pivot quickly on the policies that are causing concern,” said Patel. Fiscal oversight bodies such as the Office of Budget Responsibility are watching closely, he said.
Deutsche Bank’s Gopal admitted that the UK differs in key ways from countries like Argentina. That means that if the pound falls, it will not face additional concerns about debt repayment, as it is issuing debt in its own currency. Still, he continued, it’s not taken for granted that investors will come back.
“Investor confidence cannot be taken for granted as the global macro environment is so uncertain,” Gopal said.
Source: www.cnn.com
