The pound’s rapid decline against the dollar and loss of confidence in British policymakers is a historic moment – and points to a larger paradigm shift in global financial markets, Mohamed El-Erian said on Wednesday.
The top economist pointed to the volatility sparked by the UK’s new budget plan, which includes tax cuts for the wealthy and cuts to a planned rise in corporation tax. That sent the pound falling to a 37-year low on Friday and falling a further 2% on Monday, with analysts predicting Britain’s currency could fall below parity with the dollar next year.
The plan was criticized on Wednesday by the International Monetary Fund, which slammed the new “mini-budget” for its focus on tax cuts at a time of skyrocketing inflation. Unfunded tax cuts and debt increases will cause further damage, economists say, and the Bank of England could be forced to raise rates more aggressively than planned, raising the risk of a recession.
โIt’s amazing that this is a G7 country that has seen erratic currency and bond yield movements, a loss of confidence in policy making, now direct central bank intervention and IMF warnings in the last six days. .โ El-Erian said in an interview with CNBC.
“That normally happens in a developing country. It doesn’t happen in a G7 economy. So that’s historic. It points to the paradigm shift we’re going through and the fragility of the markets,” he added.
El-Erian has previously warned markets of a paradigm shift, pointing out that central banks are moving from quantitative easing to quantitative tightening as inflation continues to rise. This means that the era of high liquidity and ultra-low interest rates is over โ and abandoning this regime could result in stagflation, which would hit the global economy with high inflation, high unemployment and low growth.
โThe longer you stay in this la-la-land [quantitative easing], low interest rates, spaced markets, funny interventions, skewed asset allocations, the longer you stay, the harder it is to leave. And what do we see? [in the UK] is that the output is really complicated,โ El-Erian said.
To combat the potential for higher inflation, the UK will need to raise interest rates to keep inflation under control. However, this could also cause huge financial pain for households and cause unemployment and floating mortgage rates to skyrocket.
It shows the competing paths of British fiscal and monetary policy and it is crucial that the US avoids a similar situation, El-Erian said. He has previously criticized the Fed for not responding to inflation earlier, but recently urged the central bank to continue raising rates to reduce runaway inflation, despite the possibility of slower growth and high unemployment.
