William Schomberg and David Milliken
LONDON (Reuters) – The Bank of England and Britain’s new finance minister Kwasi Kwarteng will next week test their ability to jointly manage the economy with the Bank of England as they prepare to raise interest rates to fight inflation, while Kwarteng looks at tax cuts, which could push up prices.
The seemingly opposite directions of monetary and fiscal policy highlight the economic challenges facing the UK, which has the highest inflation rate
New Prime Minister Liz Truss runs conservative Party leadership, vowing to reverse what she has accused of “Treasury orthodoxy” for higher taxes and slower economic growth.
Now she and Kwarteng will have to find a way to deliver on those promises without pushing the Bank of England to raise interest rates significantly, thereby exacerbating the slowdown.
In moving into Downing Street, Truss also announced energy price caps would help cushion the impact of soaring household bills, but would cost 115 £1 billion ($8701 billion dollars) – and possibly more – at a time when UK public finances are already stretched thin.
Cap means that inflation hit a 40 year high .1% in July, then slightly in August A pullback would be lower than it should have been, but the injection of money into consumer pockets is likely to remain high for longer.
Investec economist Ellie Henderson said Bank of England Governor Andrew Bailey and his colleagues would be careful not to criticize government policy, but Will stick to its position to deal with inflation risk.
“They will cool the economy as the government tries to stimulate demand through its fiscal policy,” Henderson said. “There are divergent policy paths, but ultimately the BoE is independent and their main objective is price stability.”
Bank of England chief economist Huw Pill told parliament last week that the central bank would offset the Any medium-term inflationary pressures caused by government policies.
Faster rate rise forecast
Investors have responded to the UK’s massive fiscal stimulus by raising rates, their inflation expectations and their expectations for BoE rates bet.
UK government bonds have fallen sharply this month, with sterling hitting a near 40 year low against the dollar, while investors bet on the Bank of England to raise interest rates by a quarter more than 4.5% by the middle of next year.
It looked Thursday that this would be the seventh time borrowing costs have been raised since December, with investors only questioning the magnitude of the increase – another 0.5% – a point or bigger 75 basis points up.
The next day, Kwarteng will deliver his first fiscal statement, which will meet Trus’ pledge to reverse April’s increase in social security contributions and planned Corporate tax hike.
However, full economic and fiscal forecasts will not be released until the annual budget due later this year.
Julian Jessop, an economist who informally advises the Truss campaign, said he doesn’t think rising interest rates and tax cuts are a problem at about the same time.
“Fiscal policy is too tight, monetary policy is too loose. A little balance is not a bad thing,” he said.
“We need to get interest rates back to more reasonable and sustainable levels. If we had had a few meetings earlier, it was a reasonable tradeoff to avoid a massive recession.”
Nomura economist George Buckley said Kwarteng showed he was aware of the risks by arranging twice-weekly meetings with BoE Governor Andrew Bailey to iron out uncoordinated policies, This is his first step as Finance Minister.
“The Bank of England always has to accept what the Treasury does and make decisions behind it. So it’s not a contradiction,” Buckley said.
“Even if the government may have some looser policies and another part tightened, at least one is talking to the other side.”