over 1 year ago • 4 mins
Investors didn’t think much of the UK government’s sweeping new tax plan at first, and upon further reflection, they liked it even less.
✍️ Connecting The Dots
Britain's drama started on Friday, September 23rd, after the UK government announced a series of tax cuts that threaten to further fuel inflation – already at 40-year highs – and balloon the nation’s debt. Those fears immediately sent the pound tumbling more than 3% to hit its lowest level against the dollar since 1985. What’s more, the tax cuts – which are set to cost as much as £161 billion ($176 billion) – will be financed by new government borrowing that comes on top of the additional debt needed to fund the prime minister’s plan to freeze households’ energy bills. A huge borrowing spree at a time when interest rates are rising is not a good combo, and that pushed investors to also dump British government bonds, sending their prices plummeting.
The selloff in UK assets went into overdrive on Monday after the government doubled down on its stance and hinted at even more tax cuts to come. At one point on Monday, the pound had tumbled almost 5% to hit a record low of $1.035. The crisis caused some traders to bet that the Bank of England (BoE) would step in with emergency rate hikes to stem the pound’s bleeding, but they were quickly disappointed when the BoE rebuffed the suggestion that same day.
The BoE was eventually forced to intervene on Wednesday, pledging to buy unlimited amounts of long-term government bonds to rescue the market and avert a catastrophe for the UK’s pension funds. See, with bonds collapsing, pension funds – which hold truckloads of the asset – were facing huge potential losses. That prompted brokers to ask for more collateral to cover those potential losses in what is known as margin calls. If pension funds had started selling off investments to raise cash, it would’ve hit bond prices even more and sink the market altogether. And if they couldn’t meet their margin calls, they’d go broke, hitting thousands of Brits’ hard-earned pensions.
1. The UK’s policies are contradictory in every sense.
The UK has a serious inflation problem but the BoE’s and government’s policies are at complete odds with each other. The BoE is (rightfully) hiking interest rates to lower demand and tame inflation. The government’s tax cuts, however, have an opposite effect: they’re likely to lead to increased consumer spending and higher inflation. Making matters worse, the BoE’s emergency actions this week – buying unlimited amounts of long-term government bonds using newly minted money – are set to flood markets with cash and could add more fuel to the inflation fire.
2. The government’s plan to freeze energy bills is getting costlier.
At a price tag of more than £130 billion ($142 billion), the government’s plan to freeze households’ energy bills was never cheap and is only getting costlier as the pound tumbles. See, the UK depends on oil and natural gas imports for most of its energy needs, and those commodities are priced in dollars. So as the pound sinks against the greenback, the country’s energy import costs are rising, which means that the government will have to borrow even more to fund its plan.
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