The ‘pro-growth’ British government only made a recession more likely | Larry Elliott

TheIs Truss became Prime Minister and promised to turn things around, and she certainly did. In less than a month, the new government raised interest rates, pound crashedAnd the blow up the real estate market, She made recession inevitable and left her party on course for a defeat of epic proportions in the upcoming elections. Not bad for starters. Appearance must be good to match debut performance.

As noted by economist Mohamed El-Erian, chaos since Kwasi Quarting small budget It was more common for things that happen in developing countries than in rich and developed countries.

An emerging market-style crisis still seems far-fetched because the UK, unlike turbulent emerging markets, has its own currency and could in the last resort print sterling to cover its borrowing.

But the UK has huge trade and (and growing) budget deficits, and is dependent on investors to finance it. can gears reject criticism Everything you love about her plans, but the fact remains that the events of the past week have made the UK seem a much more dangerous place for these investors, who are now demanding higher interest rates to bet on the UK.

So, while some stability returned to the currency markets by the end of last week, with the pound returning to the levels it was at before Kwarteng announced his tax changes, this has come at a cost. Bond yields – the effective interest rate the government pays on its new loans – have risen sharply. “In fact, the UK now has to offer much higher returns to global investors to maintain the same currency value that prevailed, at much lower rates, before the announcement,” says Krishna Guha, of investment banking advisory Evercore.

The government has tried to argue that the UK is not alone in the face of higher interest rates or a weak currency. This is true, but it does not explain why the pound briefly hit a record low against the US dollar last week. Nor does it work as a reason to force the Bank of England into an emergency bond-buying program to prevent a Working on pension funds in the UK. These were the results of Truss and Quarting’s errors.

Sure, global interest rates have been rising all year, but this should have made the prime minister and finance minister more cautious about announcing a package of unfunded, unaudited tax cuts without squaring the markets first. It wasn’t as if Truss and Kwarting hadn’t been warned; They were, but they chose to ignore the advice they were given by the outside officials and experts. The decision to proceed without any form of audit From the Office of Budget Responsibility he was particularly reckless.

The upshot is that the mini-budget will have exactly the opposite results as intended. Trus attacked the orthodox treasury and the abacus economy, but both now returned with a vengeance. Whitehall departments have been asked to make efficiency savings, and the Treasury has made it clear that it has no intention of reopening last year’s spending round, although the compromises have now agreed to buy smaller volumes due to higher-than-expected inflation. It seems very likely that government benefits will not be raised in line with inflation.

And if Truss had any ideas of exercising more control over the Bank of England after it failed to prevent inflation from hitting a 40-year high, those plans were abandoned after the Threadneedle Street pension fund was bailed out last week. “The government has succeeded in making the Bank of England look good, and that is some achievement,” says one prominent economist.

The pressure on public spending is one reason why Truss is bidding farewell to hopes that her mix of tax cuts and supply-side reforms will boost growth in the coming months. The most important factor will be higher interest rates.

The day before Kwarteng’s mini budget, the bank raised rates by half a percentage point to 2.25% – deciding against a larger increase because it believed the UK was in a recession. As it happens, the upward revision to growth in the second quarter means that the economy is not actually in a recession, but the respite is sure to be short.

Huo Bell, the bank’s chief economist, warned that “Important” Interest rate increases can be expected at the next MPC meeting, and financial markets are currently expecting official borrowing costs to continue rising to 6%.

Make no mistake, if the bank pushes interest rates close to 6%, it better be prepared for a massive recession. In the past week, there were already signs of trouble ahead from the mortgage market, as more than a thousand mortgage products were pulled by lenders keeping an eye on what was happening to bond yields and the expected path of the Bank of England’s official interest rates.

Many homebuyers have taken out mortgages at higher income multiples in the belief that permanently low interest rates will make them more affordable. Now that assumption is in tatters, holders of floating rate mortgages and those whose fixed rate terms are nearing their end are facing massive increases in their monthly payments. The supply of new buyers will be quickly depleted. Home prices will fall.

The irony is that a supposedly pro-growth government’s first budget made recession more, not less, likely. The government can introduce supply-side reforms in the coming months, but if interest rates remain high to calm nervous investors, the trend growth rate will be lower rather than higher. Britain’s economic history is replete with budgets that soon crumble: Kwarteng’s is in a class of its own.

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