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Bank of England and new UK government risk policy clash

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Bank of England and new UK government risk policy clash Reuters. FILE PHOTO: THE LENDER of England (BoE) building is reflected in an indicator, following the BoE became the initial major world’s central bank to improve rates because the coronavirus disease (COVID-19) pandemic, London, Britain, December 16, 2021. REUTERS/Toby Melville

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By William Schomberg and David Milliken

LONDON (Reuters) -The Bank of England and Britain’s new finance minister Kwasi Kwarteng will test their capability to jointly manage the economy in a few days, with the BoE set to improve interest levels to fight inflation and Kwarteng eyeing tax cuts that could stoke prices.

The seemingly opposing directions of monetary and fiscal policy underscore the economic challenges for Britain, which includes the best inflation rate on the list of world’s big rich countries but can be vulnerable to slipping right into a recession.

New Prime Minister Liz Truss campaigned for the Conservative Party leadership with a vow to reverse the “Treasury orthodoxy” which she blames for higher taxes and slower economic growth.

Now she and Kwarteng will need to discover a way to provide on those promises without pushing the BoE to improve interest levels so much that it worsens the economic slowdown.

On getting into Downing Street, Truss also announced a cap on energy prices that will assist cushion the impact of soaring bills for households but will definitely cost 100 billion pounds ($115 billion) – and perhaps more – at the same time when Britain’s public finances already are stretched.

The cap implies that inflation, which hit a 40-year most of 10.1% in July before edging down in August, will peak less than it could have otherwise done, however the injection of money into consumers pockets will probably keep it high for longer.

Ellie Henderson, an economist with Investec, said BoE Governor Andrew Bailey and his colleagues will be careful never to criticise government policy but would adhere to their guns on countering inflationary risks.

“They’ll be cooling the economy at the same time once the government, through its fiscal policy, is wanting to stimulate demand,” Henderson said. “There’s divergence in the policy path but by the end of your day the BoE is independent and their definitive goal is price stability.”

The BoE’s chief economist, Huw Pill, told parliament the other day that the central bank would counteract any medium-term inflation pressure developed by government policy.

FASTER RATE RISES FORECAST

Investors have taken care of immediately Britain’s big dose of fiscal stimulus by raising their inflation expectations and their bets on BoE interest levels.

British government bonds have fallen sharply and sterling hit nearly 40-year lows contrary to the dollar this month, while investors bet on the BoE a lot more than doubling rates to 4.5% by the center of next year.

It looks set to improve borrowing charges for the seventh time since December on Thursday, with investors questioning only how big is the increase – another half-percentage-point rise or a straight bigger 75 basis-point increase.

The very next day, Kwarteng will deliver his first fiscal statement, government sources say, that will meet Truss’s promise to reverse April’s upsurge in social security contributions and a well planned corporation tax rise.

However, full economic and fiscal forecasts won’t come before annual budget due later in the entire year.

Julian Jessop, an economist who provided informal advice to the Truss campaign, said he didn’t visit a problem with interest levels increasing and taxes being cut almost simultaneously.

“Fiscal policy has been too tight and monetary policy has been too loose. A little bit of balancing isn’t a negative thing,” he said.

“We have to get interest levels back again to more sensible and sustainable levels. If we make it happen a few meetings earlier, that is clearly a reasonable trade-off for avoiding an enormous recession.”

George Buckley, an economist with Nomura, said Kwarteng had shown he was alert to the chance of uncoordinated policies by scheduling twice-weekly meetings with BoE Governor Andrew Bailey as you of his first progresses overtaking as finance minister.

“THE LENDER of England always must accept what the Treasury does and decide on the trunk of it. So it’s not inconsistent,” Buckley said.

“Even though there could be one section of government loosening policy, and another tightening, a minumum of one hand is speaking with another.”

($1 = 0.8701 pounds)

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