British Prime Minister Liz Truss on Sept. 23 unveiled the UK’s biggest tax cuts since 1972 to tackle high energy costs and inflation, and to boost productivity and wages. However, the plan has roiled financial markets, as it lacks detailed forecasts on economic growth, inflation and public finances, and involves no firm commitments to fiscal discipline.
The concerns over the plan, coupled with the US Federal Reserve’s aggressive rate hikes, Russia’s invasion of Ukraine and fears of a global recession, pushed the British pound to an all-time low against the US dollar last week. Investors also ditched UK bonds as yields spiked amid expectations of ballooning government debt and even higher inflation. British equity markets also fell, with the blue-chip FTSE 100 hitting its lowest level since March.
The volatility prompted the Bank of England to intervene by pledging unlimited purchases of long-dated bonds. However, the emergency measure is not expected to have major implications for the British central bank’s monetary policy, as it was deployed mainly to preserve financial stability. At the same time, investors would remain jittery about an ongoing bond sell-off once the two-week intervention period ends on Friday next week.
Economists and investment strategists have said the British crisis could spill over to global markets, similar to Russia’s default on its domestic debt in 1998 and the Greek debt crisis in 2009, when domestic crises led to larger financial turmoil.
Former US secretary of the Treasury Larry Summers wrote on Twitter on Tuesday that he was worried the British crisis might trigger a global crisis if the Truss government does not take steps to stop the bleeding in the pound and government bonds. As the pound is a global reserve currency, a balance-of-payment crisis in the UK could reverberate beyond the nation’s borders, Summers said.
Seven Investment Management LLP strategist Ben Kumar said fear might be contagious and warned that UK equity outflows could prompt parallel sell-offs worldwide, Bloomberg News reported on Saturday.
More importantly, the UK’s troubles this time around are not just market turmoil caused by its own fiscal policies, but a reflection of the vulnerability of financial markets as policymakers revise their monetary and fiscal strategies after years of ultra-loose monetary policies.
Specifically, there is growing tension between monetary and fiscal policymakers, as central banks hike rates to fight inflation while other government agencies prefer low interest rates, tax cuts and other incentives to spur post-COVID-19 economic recovery.
Many central banks have raised interest rates and some have adopted quantitative tightening by selling the assets they have accumulated over the years. This two-pronged tightening has led to dramatic volatility in interest rates worldwide and caused global currencies to weaken against the ever-surging US dollar, with the euro falling to its lowest in 20 years, the Chinese yuan dropping to a 14-year low and the New Taiwan dollar looking to test the critical barrier of NT$32 against the greenback.
Over the past two years, the world has made a concerted effort to combat the COVID-19 pandemic. However, countries need to work more closely together in the face of a likely vicious cycle triggered by the synchronized rate hikes to avoid a global financial crisis. As for Taiwan, the government must make financial, economic and industrial adjustments to cope with the challenge of a potential global recession.
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