By AFP
LONDON: Britain’s massive and unfunded tax cuts unveiled in a recent budget have led to a major loss of market confidence in the country’s ability to service its debt.
The pound sank against the dollar Friday after Prime Minister Liz Truss sacked finance minister Kwasi Kwarteng.
Sterling tumbled 1.2 percent to $1.1188 but this was comfortably above the record dollar-low close to parity it reached in the immediate aftermath of the budget last month.
Yields on UK government bonds, or gilts, have meanwhile soared following the heavily-criticised tax and spend announcement by Kwarteng.
The extent to which the storm could spread to other markets or even degenerate into a financial crisis is outlined below in questions put forward to economic experts.
How could other markets be affected?
Surging yields on long-term UK government bonds triggered emergency buying of such debt by the Bank of England (BoE) to avoid a liquidity crisis — the result of too many sellers and not enough buyers.
The intervention ends Friday and market watchers cannot be sure which direction assets will go in amid current volatility.
Markets are fearful that the unfunded tax cuts could send state debt ballooning further, having soared in recent years on supporting the economy through the Covid pandemic.
ALSO READ | UK’s new finance chief scraps ‘nearly all’ government tax cut plans in humiliation for PM Truss
The government is not expected to provide details of how it will fund the tax cuts until October 31.
“We don’t seem to be at that point yet” of contagion on other markets, Paola Binns, a fund manager at Royal London Asset Management, told AFP.
She noted, however, that concerns could extend to government bonds in other highly indebted nations such as Italy.
According to Eiko Sievert, a director at Scope Ratings, about 29 percent of the UK gilt market is held by overseas investors.
“The massive corrections in this market that we are seeing are therefore also having international repercussions,” he said.
How far have pension funds been saved?
The BoE intervened in particular because British pension funds, which hold almost one third of long-term government debt according to Sievert, found themselves under pressure.
Some funds have used so-called Liability Driven Investment. LDIs are linked to financial derivatives and intended to help ensure that the income generated by the assets covers their long-term commitments, namely retirement pensions.
However, market volatility has caused the value of assets, notably traditional haven gilts, to melt.
This forced pension funds to sell gilts to quickly access liquidity that would cover their commitments, creating a vicious circle.
Despite the turmoil, British pension funds are not seen as being threatened with insolvency, according to experts.
ALSO READ | ‘Sorry for going too far too fast’: UK PM Truss apologizes for economic mistakes but vows to stay on
Their varied assets combined are worth more than £2 trillion ($2.3 trillion), while they can call upon other help in the case of liquidity shortages.
For example, they can ask companies whose pension funds they manage to refinance debt. And should such companies face bankruptcy themselves, then a UK pension protection fund would kick in.
How have other businesses been impacted?
Higher bond yields have pushed up interest rates retail banks charge businesses and individuals, further adding to a cost-of-living crisis impacting Britain.
The banks’ loans, such as mortgages, are financed on markets which also react to changes in government debt.
Fixed mortgages rates have soared to around six percent, far higher than in recent times.
Although such rates began rising this year from around two percent as the BoE raised borrowing costs, they have soared in recent weeks on budget fallout.
The central bank is also expected to keep raising interest rates to try and cool sky-high UK inflation.
What are the parallels with the 2008 crisis?
Some experts see parallels with the situation in 2008 when the global financial crisis erupted.
“Britain is facing a twin crisis,” said Tony Syme, an economics lecturer at the University of Salford. “Anxiety for millions of households and a financial crisis that has too many parallels with 2008-09.”
But he stressed that the situation was far from the financial crisis that triggered bankruptcies and bailouts of huge banks worldwide.
LONDON: Britain’s massive and unfunded tax cuts unveiled in a recent budget have led to a major loss of market confidence in the country’s ability to service its debt.
The pound sank against the dollar Friday after Prime Minister Liz Truss sacked finance minister Kwasi Kwarteng.
Sterling tumbled 1.2 percent to $1.1188 but this was comfortably above the record dollar-low close to parity it reached in the immediate aftermath of the budget last month.
Yields on UK government bonds, or gilts, have meanwhile soared following the heavily-criticised tax and spend announcement by Kwarteng.
The extent to which the storm could spread to other markets or even degenerate into a financial crisis is outlined below in questions put forward to economic experts.
How could other markets be affected?
Surging yields on long-term UK government bonds triggered emergency buying of such debt by the Bank of England (BoE) to avoid a liquidity crisis — the result of too many sellers and not enough buyers.
The intervention ends Friday and market watchers cannot be sure which direction assets will go in amid current volatility.
Markets are fearful that the unfunded tax cuts could send state debt ballooning further, having soared in recent years on supporting the economy through the Covid pandemic.
ALSO READ | UK’s new finance chief scraps ‘nearly all’ government tax cut plans in humiliation for PM Truss
The government is not expected to provide details of how it will fund the tax cuts until October 31.
“We don’t seem to be at that point yet” of contagion on other markets, Paola Binns, a fund manager at Royal London Asset Management, told AFP.
She noted, however, that concerns could extend to government bonds in other highly indebted nations such as Italy.
According to Eiko Sievert, a director at Scope Ratings, about 29 percent of the UK gilt market is held by overseas investors.
“The massive corrections in this market that we are seeing are therefore also having international repercussions,” he said.
How far have pension funds been saved?
The BoE intervened in particular because British pension funds, which hold almost one third of long-term government debt according to Sievert, found themselves under pressure.
Some funds have used so-called Liability Driven Investment. LDIs are linked to financial derivatives and intended to help ensure that the income generated by the assets covers their long-term commitments, namely retirement pensions.
However, market volatility has caused the value of assets, notably traditional haven gilts, to melt.
This forced pension funds to sell gilts to quickly access liquidity that would cover their commitments, creating a vicious circle.
Despite the turmoil, British pension funds are not seen as being threatened with insolvency, according to experts.
ALSO READ | ‘Sorry for going too far too fast’: UK PM Truss apologizes for economic mistakes but vows to stay on
Their varied assets combined are worth more than £2 trillion ($2.3 trillion), while they can call upon other help in the case of liquidity shortages.
For example, they can ask companies whose pension funds they manage to refinance debt. And should such companies face bankruptcy themselves, then a UK pension protection fund would kick in.
How have other businesses been impacted?
Higher bond yields have pushed up interest rates retail banks charge businesses and individuals, further adding to a cost-of-living crisis impacting Britain.
The banks’ loans, such as mortgages, are financed on markets which also react to changes in government debt.
Fixed mortgages rates have soared to around six percent, far higher than in recent times.
Although such rates began rising this year from around two percent as the BoE raised borrowing costs, they have soared in recent weeks on budget fallout.
The central bank is also expected to keep raising interest rates to try and cool sky-high UK inflation.
What are the parallels with the 2008 crisis?
Some experts see parallels with the situation in 2008 when the global financial crisis erupted.
“Britain is facing a twin crisis,” said Tony Syme, an economics lecturer at the University of Salford. “Anxiety for millions of households and a financial crisis that has too many parallels with 2008-09.”
But he stressed that the situation was far from the financial crisis that triggered bankruptcies and bailouts of huge banks worldwide.
