Collision between the Bank of England and the new government risk policy in the UK

Collision between the Bank of England and the new government risk policy in the UK

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Written by William Schomberg and David Milliken

LONDON (Reuters) – The Bank of England and Britain’s new Chancellor of the Exchequer Kwasi Quarting will test their ability to jointly manage the economy next week, as the Bank of England is set to raise interest rates to fight inflation and Quarting looks to tax cuts that could raise prices.

The seemingly opposing directions of monetary and fiscal policy underscore the economic challenges facing Britain, which has the highest inflation rate among the world’s major rich nations but is also at risk of slipping into recession.

New Prime Minister Liz Truss has campaigned for leadership of the Conservative Party, vowing to reverse the “Treasury Doctrine” that she blames for higher taxes and slowing economic growth.

Now she and Quarting will have to find a way to make good on those promises without putting pressure on the BoE to raise interest rates so much that they exacerbate the economic slowdown.

Moving to Downing Street, Truss also announced an energy price cap that would help mitigate the impact of higher household bills, but would cost £100 billion ($115 billion) – and possibly more – at a time when Britain’s public finances are strained. Already. .

The cap means that inflation, which hit a 40-year high of 10.1% in July before declining in August, will peak lower than it would have otherwise, but pumping money into consumers’ pockets is likely to keep it high. for a longer period.

Eli Henderson, an economist at Investec, said Bank of England Governor Andrew Bailey and colleagues would be careful not to criticize government policy, but would still stick to their guns in the face of inflation risks.

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“They will calm the economy at a time when the government, through its fiscal policy, is trying to stimulate demand,” Henderson said. “There is a difference in the course of policy but at the end of the day the Bank of England is independent and its main objective is price stability.”

The Bank of England’s chief economist, Howe Bell, told Parliament last week that the central bank would face any medium-term inflationary pressure caused by government policy.

Expect higher prices

Investors have responded to Britain’s heavy dose of fiscal stimulus by raising inflation expectations and betting on interest rates at the Bank of England.

British government bonds have fallen sharply and the pound hit a nearly 40-year low against the dollar this month, while investors have bet on the Bank of England more than doubled to 4.5% by the middle of next year.

It appears set to raise borrowing costs for the seventh time since December on Thursday, with investors only questioning the size of the increase — another half a percentage point increase or a larger increase of 75 basis points.

The next day, Kwarteng will present his first financial statement, according to government sources, which will fulfill Truss’ promise to reverse an increase in April’s Social Security contributions and a planned increase in corporate tax.

However, the full economic and financial outlook will not come until the annual budget due later in the year.

Julian Jessup, an economist who has given unofficial advice to the Truss campaign, said he sees no problem with higher interest rates and tax cuts almost simultaneously.

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“Fiscal policy is very tight and monetary policy is very loose. A little balance is not a bad thing,” he said.

“We need to get interest rates back to more reasonable and sustainable levels. If we get there before a couple of meetings, that’s a reasonable trade-off to avoid a massive recession.”

George Buckley, an economist at Nomura, said Courting showed he was aware of the risks of uncoordinated policies by setting twice-weekly meetings with Bank of England Governor Andrew Bailey as one of his first steps to becoming Chancellor of the Exchequer.

“The Bank of England always has to accept what the Treasury is doing and make a decision on that. So it’s not a contradiction,” Buckley said.

“Even if there is one part of government easing policy, and another tightening, at least one hand is talking to the other.”

(dollar = 0.8701 pounds)

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