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The United Kingdom: understanding the crisis in three questions

“Financial crisis”, “panic” etc. For several days, the qualifiers have been multiplied to qualify the difficulties that the UK is currently going through. Why are we talking about a crisis? How can we explain it? And what was the reaction of the Bank of England? Three point decryptions.

Why are we talking about a crisis in Britain?

In the past week, the UK has been going through a period of financial panic. On the one hand, this results in fall in the value of the pound and on the other side of rapidly deteriorating state funding conditions.

The British pound first lost almost 20% of its value against the dollar since the start of 2022. The fall of the pound accelerated this summer : The British currency has actually lost almost 12% of its value since the beginning of August.

It should be noted that the dollar appreciated against most world currencies. The pound’s fall, which is more pronounced than other currencies such as the euro, however, encourages the search for explanatory factors specific to the United Kingdom.

At the same time is UK funding conditions have deteriorated sharply over the past few weeks. On September 27, the required interest rate on government bonds actually reached 4.5%. This is an increase of almost 110% since 1eh June.

UK government bond yield developments

How can we explain the crisis in the United Kingdom?

Like several other advanced economies, the UK has faced several imbalances since the beginning of 2022: risk of recession, high inflation, etc.

Inflation reached 9.9% year-on-year in the UK in August 2022.

However, the United Kingdom sank into crisis on Friday, September 23. The reason: presentation of budget measures by Liz Truss, appointed Prime Minister earlier this month. In particular, it announced new tax cuts. This policy, which is considered not credible by the financial markets in the current context, caused the fall of the pound and a further deterioration of public financing conditions.

A concern associated with these tax breaks, e.g. expressed by the International Monetary Fund (IMF), is that they will provide further fuel toinflation and deteriorate the macroeconomic context. The IMF is particularly concerned that the announced tax cuts are not targeted and largely concern households with high incomes. Specifically this distrust reflected in financial players turning away from assets denominated in sterling (especially government bonds), contributing to the depreciation of the pound and the fall in the price of these assets.

The fall in the value of the pound sterling fuels inflation. It actually causes the increase in the price of imported goods, especially energy and a large part of food.

What measures has the Bank of England taken?

In this context of crisis, the Bank of England was forced to act quickly on Wednesday 28 September. In particular, to calm the financial markets, the central bank of the United Kingdom announced that it would intervene “as much as necessary” by buying UK bonds. This is particularly intended to counter the deterioration of UK funding conditions by supporting the price of government securities. These securities purchases are currently scheduled to stop on October 14th.

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