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A sense of normalcy is returning to British politics following the Conservative Party’s nomination of Rishi Sunak as the next prime minister. But the enormity of the financial task ahead has not diminished. What the government does next on the fiscal front will determine how much higher the Bank of England believes it needs to push interest rates down – and how much economic pain businesses and consumers face in the coming winter.
Sunak’s appointment was hailed by financial markets as promising political stability after Liz Truss’ disastrous surge in growth through unfunded tax cuts wrecked the pound and pushed up government bond yields last month. Sterling is some 10% stronger against the dollar from the record low hit on September 26th, while gilt yields have calmed down from the high levels that roiled pension funds.
At the height of the recent crisis, bond investors were charging the UK up to £20 billion in additional annual interest costs. Yields may still be more than double what they were at the start of this year, but the UK no longer looks like a pariah in the market compared to its US and European peers.
With the government no longer playing fast and losing on fiscal policy, traders have scaled back their expectations of how much tightening the UK central bank thinks it will need to do. Comments by BOE Deputy Governor Ben Broadbent last week on “whether official interest rates need to rise by what financial markets are currently pricing in” helped dampen speculation about the peak in interest rates, which was fueled by his Analysis has been reinforced that a reference interest rate of 5% could reach up to 5% of gross domestic product. His colleague on the Monetary Policy Committee, Catherine Mann, backed his comments over the weekend, saying that “perhaps the curve was too aggressively valued”. Next week’s BOE meeting is now expected to introduce a 75 basis point hike that will bring the official rate to 3%.
The recent turmoil has eroded the UK economy. Figures released on Monday showed that S&P Global’s composite survey of UK purchasing managers for October fell to 47.2, further below the 50 level that signals a contraction. Things are getting worse, with the new orders index for manufacturers falling to 38.6. Bloomberg Economics expects the UK’s annual GDP to be slashed by 1.5% on the back of six weeks of Trussonomics aftershocks and the economy to contract by 1.4% next year.
There is also a gap of about £30 billion ($34 billion) in the government’s economic plans that the Office for Fiscal Responsibility wants to see filled. The government’s budget statement, due to be presented by current Chancellor of the Exchequer Jeremy Hunt on October 31, must strengthen the government’s fiscal probity. And in the coming months, the Sunak government must specify what will replace the blanket energy price cap that Truss introduced, which is now due to expire in April.
Sunak has shown some ingenuity as chancellor with both his pandemic working furlough scheme and his post-lockdown support for restaurants. That creativity, along with steely determination and more than a dash of luck, will be essential to repairing the self-harm the UK has suffered over the past month.
More from the Bloomberg Opinion:
• Rishi Sunak is a new and old-fashioned Tory: Adrian Wooldridge
• The Bank of England is the central bank’s crash test dummy: Marcus Ashworth
• Even with Truss gone, her about-face will still put Households under pressure: Andrea Felsted
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Markets Strategist at Haitong Securities in London.
For more stories like this, visit bloomberg.com/opinion
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