By Isabella Green
Recently there has been a question on all our minds: will Liz Truss outlast a cabbage? We now know the answer is no. This comes as a relief to all who have been following the near disastrous mini-budget and likely all those working at the Bank of England. Truss’s short term as Prime Minister is now over and we are back to the scramble of finding a new incumbent for 10 Downing Street. The pound is in a rough position and there appears to be little end in sight. Additionally, as Parliament is becoming increasingly unstable, bond markets are following suit. It is clear that the British economy is on unsteady ground, making it riskier for investors. There are multiple factors that have continued to contribute to market instability; however, it does not take much analysis to consider the disastrous effects of Truss’s mini-budget. It is difficult to determine the longer term impact of these developments, mostly due to the fact that the conditions that created it are either about to be overturned by Hunt or have already been discarded by Truss. However, the rise in bond yields, especially for the longer term bonds, does not bode well. Government bonds are considered stable specifically because they are government backed and governments should be more capable of managing their finances than institutions that are not beholden to the entire British public.
It is clear that the road to recovery will be long and questions over exactly how long are causing investors to move away from British government bonds. It is not a great wonder that investors would need higher returns on investment to involve themselves in the British bond market. With so much confusion over the next steps that will be taken to counteract the ripple effects of the pandemic, it cannot be a surprise that investments in British government bonds are in a difficult position. The bond problem revolves around the debt the government is currently in and concerns debt could grow, especially when Truss’s government attempted to launch new tax cuts. Bringing money back to British bonds means stabilizing the economy and enacting heavy damage control measures. Higher yields do encourage investment; however, the need for a higher monetary incentive to invest in the British government is concerning. With the constant turnover in the top government ranks, especially those most involved in economic measures, this hesitance is understandable. The government is aware of this issue and they are selling tens of billions worth of government bonds. This will give them an influx of cash and help in the fight against rising inflation that has been one of the primary concerns for months. There is also the issue of higher government borrowing in comparison to this time previous years and even the predicted number for this year. Government debt is not necessarily a bad thing, but when there become concerns that the government will be unable to repay debts this issue becomes more serious.
Unfortunately for the rest of the world, the effects of poor fiscal management can be felt across national borders. We can see that the effects of inflation have reached far and wide. As the UK takes a turn it will bring other economies down with it. The United States has strong economic and political ties to the to the United Kingdom. As a result, many American banks are questioning their holdings of British bonds. The Bank of England cannot only act for their interests at home, they must consider the ripple effects that are beginning to arise. While the effects have been smaller in the United States, it is not a guarantee that further action would not cause more harm.
The United States is not the only country that will face the repercussions of British mismanagement. The Bank of Japan has enough problems with domestic bond rates and the devaluation of the yen. The Japanese economy is more dependent on the United States than it is on the United Kingdom; however, there are still economic ties between all parties. The Bank of Japan is seeing similar issues to the United Kingdom in regards to bond rates and investor confidence. Japan does not have the same inflation concerns as the United Kingdom; however, it is having to implement the same mass government bond purchasing schemes. As of yet, Japan has been much more capable in handling the economic downturn. With UK bonds seeming risky, it is possible for Japanese bonds to appear favourable. Although the high yield rates can act as an indicator for trouble ahead there are dozens of tools that the Bank of Japan, and by extension the Bank of England, can still implement to get ahead of this issue.
The larger plan for the economy is still unclear, as is the ability of any future Prime Minister to swiftly counteract what has already been done. It appears that the former Prime Minister and her cabinet were at odds with the Bank of England. With growing concerns and predictions of an impending recession it is perhaps not in the best taste to pit yourself against your own central bank, even for the chance of moderate political gain. Hunt is the person of the hour with the responsibility of holding the two forces together, at least temporarily. He is attempting a less adversarial position than Kwarteng, his predecessor who stepped down after the colossal failure that was the mini-budget. The position is not an enviable one; however, Hunt is sure to use the opportunity to move out of the background of politics. With so many changes in policy that this administration has announced, it is difficult to predict if this shift is just another temporary decision. Working with the Bank of England seems a clear and obvious choice; however, we would be overly optimistic to consider this a guarantee. Each group is operating in reaction to the actions or predictions of the other groups with different interests and goals, creating a dichotomy that must be resolved for recovery.