Markets turn against UK as outlook for inflation and growth darkens

(Bloomberg) – Markets have turned against the UK for the second time in less than a year as the outlook for inflation and growth darkens for an economy that is already lagging behind others Group of Seven countries.

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As the Bank of England scrambles to contain soaring prices, investors have bet interest rates will rise to their highest level in 25 years. The pound has strayed even further from those expectations than at any time since Prime Minister Liz Truss’ ill-fated budget rocked markets in September.

While investors gave his successor Rishi Sunak credit for stabilizing the situation earlier this year, two crucial reports last month showed stubbornly high wages and prices – despite the fastest rise in costs. loan in three decades.

“Markets are questioning the credibility of UK politics,” said Adam Cole, chief currency strategist at RBC Capital Markets. “The divide between rates and money is not yet as wide as it was then, but it is moving in the same direction.”

The next two weeks will be crucial in shaping the outlook.

On Sunday, BOE Governor Andrew Bailey speaks in France and then appears the next day alongside Chancellor of the Exchequer Jeremy Hunt at Mansion House in London. Official employment data is released on Tuesday and monthly GDP data on Thursday. Inflation figures for June are published on 19 July.

Bailey told BBC Newsround on Thursday that he “expects inflation to come down quite sharply” in the coming months, but another overshoot in wage growth or consumer prices would raise concerns about the fact that the BOE might have to tighten its policy too much and cause a recession.

Policymakers who as recently as March were weighing when to pause rate hikes quickly took a more aggressive stance, offering a surprise half-point hike to 5% last month.

Investors are now betting that the BOE will have to raise its key rate above 6.5% to calm inflation, the highest in the G-7.

The sudden loss of confidence has reignited rumors that the UK is “turning into a submerged market”, as former US Treasury Secretary Larry Summers put it during last year’s crisis. The UK is “Europe’s stagflationary sick man,” said Bank of America chief investment strategist Michael Hartnett. Cole warned that “betting on an unexpected drop in inflation in the near term would seem like the triumph of hope over experience.”

Instead of Truss, the focus is now on the BOE’s ability to meet its inflation-fighting target.

“If the bank had credibility, it would be able to withstand some – not all – of the market pressure for higher rates,” said Gerard Lyons, chief economic strategist at NetWealth. “But because the bank lacks credibility, it responds to markets, not directs them.”

Negative market sentiment has real consequences. While the pound is the best performing G-10 currency this year, the Treasury this week paid the highest interest rate for a new bond issue since 2007. Mortgage costs are increasingly unaffordable – one percentage point above the BOE’s 5% pain threshold was identified as a significant household burden. House prices are falling at their fastest rate since 2011. Business bankruptcies are near historic highs.

And yet the economy is more resilient than expected, Bailey said, with labor shortages supporting wages. “It keeps the pressure on the Bank of England to raise rates further,” said George Buckley, European economist at Nomura.

It’s a dramatic fall from grace for the UK in the year that marks the one-year anniversary of Boris Johnson’s resignation.

Not so long ago, Britain was proud of its halfway economic model – a mix of American free market and European welfare state policies. Low taxes, low unemployment, flexible labor markets and universal health care. The UK has usually grown faster than its European peers without the social divisions that plague America. Today is the cautionary tale of the world.

Italian Prime Minister Georgia Meloni planned a Truss-style assault on state institutions until the British budget drove up market interest rates in September. In the process, Britain gave the International Monetary Fund a practical, real-time example of why cutting taxes in an inflationary shock was a bad idea.

Foreign investors vote with their feet. France has overtaken Britain at the top of European investment charts compiled by EY since 2019, and the FTSE 100 has been left out of a stock market rally that has swept across the US, Europe and Japan this year . Industrial gems like semiconductor maker Arm are listed overseas.

What Bloomberg Economics says…

“The next batch of UK employment data will be crucial in determining the Bank of England’s next policy decision in August – another outsized 50 basis point hike could still be on the cards. Either way, the UK economy is expected to contract in May as the extra national holiday likely weighed on activity.

—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for WEEK AHEAD.

Business leaders accuse the declinist narrative of a lack of political vision. Brexit was a negation of the British economic model – an entry point to the EU single market with limited labor laws, not a declaration of what the UK would be like. It remains undefined.

Sunak wants lower taxes and strong public services, but insists tax cuts will only come when the UK can afford them. With higher rates adding around £20billion a year to debt, the Treasury has little to no scope for freebies.

In the meantime, Sunak is building a totally different economy than the one he talks about. At least 4 million more Britons have been sucked into income tax since 2020. Corporation tax has risen from 19% to 25%. The UK’s overall tax burden is the highest since the end of the Second World War.

The contradiction between vision and reality speaks of a country in the throes of an identity crisis, and the opposition Labor Party has seized the opportunity.

High rates are the ‘Tory mortgage bomb’, says Labor. “There is more than a touch of the 1970s to our current economic situation,” Labor leader Keir Starmer said on Thursday, linking the current malaise to the last time the UK was “the sick man of the world”. Europe”.

With elections due next year approaching, the question of Britain’s growth strategy will come into sharper focus.

–With help from Andrew Atkinson, Greg Ritchie and James Hirai.

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