The first fiscal policy announcement from new British Prime Minister Liz Truss’s government last Friday week was met with one of the most pronounced markets sell-offs in recent history. The sterling foreign exchange and credit markets perceived this as an “erosion of confidence” and led to high market volatility.
The pound sterling plummeted, hitting an all-time low against the US Dollar in early last Monday morning, while the UK 10-year gilt’s yield rose sharply by about 1.5 per cent, to its highest level since 2008, as disarray continued following the new Chancellor Kwasi Kwarteng’s ‘mini-budget’.
The mini budget mainly featured broad tax cuts amounting to a huge £45 billion, not seen in Britain since 1972, and some £60 billion in energy support to households and businesses. Its sole aim is to boost growth through tax and regulatory reform, with the new finance minister indicating that more tax cuts could be on the way.
These will be funded mainly by borrowing, leading to the biggest increase in borrowing in 50 years, notwithstanding that the UK is facing slowing growth and twin deficits.
This massive loose fiscal policy was viewed negatively by the financial markets, as it is not complementary with the Bank of England’s prevailing £80 billion quantitative tightening implementation, over the coming year.
This fiscal development will create pressure on the BoE that will now need to tighten policy more aggressively than it otherwise would have in order to counteract the additional inflationary pressures stemming from these fiscal stimulus measures.
On Thursday, the BOE extraordinarily announced that it will buy £65 billion of UK gilts in order support the credit markets.
In the meantime, the Conference Board reported on Tuesday that consumer confidence in the US improved more than expected, as the consumer confidence index rose to 108.0 in September from an upwardly revised 103.6 in August.
The index improvement was better than the 104.3 level expected and was the second consecutive monthly gain, driven particularly by jobs, wages and declining petrol prices.
Purchasing intentions were diverging, with home purchasing intentions lower, while intentions to buy cars and appliances were higher. The improvement in confidence, which was partly driven by declining fuel prices, which fell to their lowest level year-to-date, may augur positively for consumer spending in the final months of the year. However, rising interest rates and inflation remain a drag to consumer sentiment.
Finally, the World Bank revised lower its economic growth forecasts for the East Asia and the Pacific region. It now forecasts the region to expand 3.2 per cent in 2022 instead of 5.0 per cent projected in April, much lower than last year’s 7.2 per cent growth.
China, which accounts for some 86 per cent of the region’s output and which previously led the recovery, is projected to grow by 2.8 per cent this year, below the government’s 5.5 per cent target.
This is a sharp slowdown from last year’s 8.1 per cent growth, as the zero-COVID measures disrupted supply chains, industrial and services production, domestic sales, and exports. Global economic slowdown, rising interest rates, inflation and policy distortions will cause headwinds to growth to this region.
This report was compiled by Bank of Valletta for general information purposes only.