Uncertain Economic Times Ahead for the United Kingdom
On September 26th, 2022, the U.K.’s economy, the 6th largest in the world, nearly collapsed as the British pound fell 5% to its lowest value ever at just 1.03 USD (Mccrank). This left the U.K. teetering on the edge of a very serious potential economic crisis. To illustrate the severity of the situation, nearly ¾ of pubs in the U.K. are currently facing permanent closure (Rowsell), citizens are purchasing generators and torches as they anticipate blackouts in the coming winter (Ziady), and police are preparing for an incredible surge in violent crime and civil unrest as the cost of living will make for a very tough winter for the country (Anderson). The driver for all of this was the announcement from the new U.K. government that they would be borrowing billions more pounds as a part of their mini-budget which sent the markets tumbling out of control (Bruce). Unfortunately for the U.K., all of this is occurring while a recession looms on the global economy set to further disrupt the country in many ways. The country’s inflation has gone up over 10% this year (Gooding) and when you couple this with the fact that the UK is the only G7 country that has not recovered economically from the Covid-19 pandemic, things are not looking great (Inman). When the U.K. announced it would be borrowing more money after all these things happened, people lost faith that the government could pay the money back, as its public debt has already risen above the size of the economy (Milliken).
The UK has a number of issues: The currency has lost nearly 50% of its value since 2008, a cost of living and energy crisis, excessive borrowing, Brexit, constant leadership changes, rising crime rates, rising interest rates, surging house prices, and over 200,000 deaths from covid. These issues are the results of deeper underlying economic and political issues and austerity that the economy had faced since the housing crisis. However, what might be the single worst wound the U.K. has suffered, and what may have potentially doomed the country was the withdrawal from the EU in Brexit, as it was left totally unprepared for the coming pandemic. The U.K. is the 10th largest economy adjusted for PPP (World Bank) and it built that economy out of being a highly developed social market relying heavily on trade. Naturally, the pandemic posed a grave threat to the U.K. and did nearly irreparable damage to the economy as GDP shrank a record 20.4%, the most since 1709 (Goodman and Atkinson). This weakness in the UK has led to foreign investors taking their money elsewhere and is anticipated to fall by 37% with France poised to overtake the UK with foreign investment in the near future.
As if intending to solidify doom for the economy, the recently elected (and since resigned) Liz Truss enacted a drastic policy change for the UK when she put a 2,500-pound cap on what a typical household can spend on energy for 2 years (Ramsey). This was intended to save the average family around 1,000 pounds per year in an effort to control the energy crisis; However, the plan did not work as intended and actually cost the country 100 billion pounds (Reuters) as parliament had to finance this policy through their own government debt. This drove the country’s inflation rate even higher as experts warn inflation could hit 18.6% in January of 2023 completely negating the savings supposedly generated from the policy (Batchelor-Hunt). Not long after, the UK announced its largest tax cut since 1972 as it intended to stimulate the economy, but this package would end up costing the UK over 160 billion pounds and consequently raise inflation and debt, sending the country further down the path to destruction (Aldrick). Investors did not take too well to this idea and one of the largest problems with this plan is the effect it would have on pension funds in the U.K. These pension funds invest themselves within gilts (bonds issued by the UK government) and in order to protect against falling rates on the gilts, pension funds must put up collateral. Under normal circumstances, this would not be an issue as the gilt is a relatively safe investment, however, when the mini-budget was announced, the price of the gilt sank drastically and yields rose sharply, meaning that pension funds had to put up a lot of collateral within a number of hours. This created a “doom loop” because so many funds were selling gilts to meet payment demands which continued to push yields higher causing more selling and so on (Wilson). To stop this cycle, the Bank of England stepped in when pension funds were just hours from collapse and purchased 65 billion worth of gilts to stabilize the price which surprisingly worked. However, assuming that the pound was going to inflate in value, people began selling it, dropping the pound further and further to where it is now just over 1 USD.
Although the action taken by the UK worked to an extent, it is nothing more than a band-aid stopping the bleeding without treating the root issue. Even with additional rate hikes, the only thing certain is that citizens in the UK will have to spend 3-4x more on a mortgage making home ownership nearly impossible. This will also be happening as workers will most likely continue to strike over pay and investors will get increasingly more uncertain about the stability of the economy and its future. This is only the beginning, there would have to be drastic shifts and changes within policy and even that may not be able to hold the country together. The cracks in the U.K. are showing and shedding light on much larger problems that have been patched up rather than actually addressed and corrected. This is why the pound has lost so much in value and this is why it will continue to lose value despite whatever policy changes and rate hikes get instituted. Given the circumstances, it is likely that the pound will be weaker than the dollar for quite some as it was already weakening prior to the mini-budget, inflation, and many different emerging catalysts mentioned throughout this report. These variables combined could potentially and most likely spell disaster for the country and its currency.
Works Cited
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