Is there a pilot in the plane?

10th October 2022
-IAM, News

Hugues Chevalier, Economist

On 3 October, the new British government made a U turn on its fiscal policy, at the risk of losing all credibility just a few weeks after being sworn in. Indeed, after presenting his tax plan (mini-budget) on 23 September, Chancellor of the Exchequer Kwasi Kwarteng and British Prime Minister Liz Truss triggered a shock wave unprecedented since the 1980s in the financial markets and made fools of themselves by their amateurism and incompetence in economic and financial policy. What has happened in the last few days? Firstly, with the aim of accelerating economic growth, the government has committed itself to lowering taxes, especially for the wealthiest households with the abolition of the 45% tax rate, without increasing tax revenues. On the expenditure side, and in parallel, the freezing of electricity and gas bills for households is expected to generate billions of pounds of additional expenditure for the state. In total, the two measures (lower revenues and higher spending) would lead to an uncontrolled increase in the country’s debt. With economic growth at its lowest due to inflation and the energy price shock, the markets have deemed that there is an increased risk to the UK’s debt. The consequences of these government plans were an unprecedented devaluation of the pound sterling, further exacerbating the impact of imported inflation, and a sharp rise in interest rates affecting millions of borrowers, particularly households with their mortgages. The Bank of England had to intervene in the markets by buying up sovereign bonds in an emergency to try to restore some ‘confidence’. However, this action is totally at odds with the fight against inflation that the central bank has been conducting for several months. As a result of this monetary “crisis”, the Bank of England could even be forced to accelerate its monetary tightening even further and provoke a more serious housing crisis and/or recession than expected. Worse still for the UK government, the IMF has reminded the UK that in times of global crisis (energy shock, war in Ukraine) basic financial and fiscal rules must be respected by the G7 countries to avoid any domino effect in the world.