UK Economy is doomed: Currency crash The British economy has been in a crisis since the new UK administration, led by Prime Minister Liz Truss and Chancellor of the Exchequer (Finance Minister) Kwasi Kwarteng, unveiled its “mini-Budget” last week, drawing harsh condemnation from all around the globe.
According to reports, the new UK budget might “undermine monetary policy” and “raise inequality” in Britain. This is according to the International Monetary Fund (IMF).
What are the direct repercussions?
At a time when the economy is already battling with unprecedented inflation fueled by increasing prices of imported Russian gas in the wake of the crisis in Ukraine, a severe decline in the value of the pound relative to the US dollar will effectively make the UK’s imports more expensive.
In the UK, government bonds are referred to as gilts.
A sharp increase in gilt yields (or the effective interest rate charged) suggests that the cost of borrowing for the government has increased just as it plans to significantly increase borrowings, partly to help the poor weather the cost-of-living crisis and partially to jump-start the UK’s sluggish economy.
Model by Truss-Kwarteng
According to the Truss-Kwarteng model, the government will borrow more money overall. This predicts an increase in interest rates. In a mature economy like the UK, this would typically not be cause for concern.
Rich economies like the US and the UK frequently see an increase in global investment when interest rates rise. This is due to the widespread belief that governments would never have trouble repaying their obligations.
The UK government asserts that tax reductions will result in a significant increase in economic activity, which will lower the “debt-to-GDP” ratio. However, the markets (read: creditors) are not persuaded that growth will occur at the government’s desired rate.
Investors have doubts about the UK government’s capacity to repay the loan. For this reason, they are hesitant to lend money to the UK, which is reflected in the sale of UK government bonds and, as a result, sends gilt rates skyrocketing.
The mini-Budget may increase the UK’s cost-of-living issues and inflation, which is another issue.
For the purpose of reducing inflation and consumption, the Bank of England has been boosting interest rates. However, there are two ways that this battle against inflation might be compromised.
• First, more money in people’s hands might encourage spending and inflation.
• Second, the steep decline in the value of the pound will increase the price of imports, particularly those related to energy.
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