Axios Macro

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September 23, 2022

So much for a quiet Friday. Global markets are reeling after the U.K. government unveiled a larger-than-expected fiscal package — a gamble to jolt economic growth. Below, we'll explain why investors are treating Britain more like an emerging market.

  • Plus, staying across the pond, a look at the country's looming currency transition. 💷 🇬🇧

Situational awareness: Our colleague Hans Nichols scoops that the Biden administration may seek to oust World Bank president David Malpass after he appeared reluctant to say he believes in climate change at an event last week.

Today's newsletter, edited by Kate Marino and copy edited by Katie Lewis, is 799 words, a 3-minute read.

1 big thing: Britain is the newest emerging market

British prime minister Liz Truss

Prime Minister Liz Truss. Photo: Chris J. Ratcliffe/Bloomberg via Getty Images

The newly formed British government rolled out its fiscal plans this morning — and the reaction from global financial markets is beyond stunning.

  • Essentially, the markets are treating the U.K. the way they do emerging markets, which are viewed as not having the same reliable, disciplined institutions setting economic policy as the richest nations.

Why it matters: Beyond the unique crises facing Britain right now, we're in an upside-down world compared to that which prevailed during the 2009-2019 period. Policymakers worldwide will want to be on notice that deficits may matter again, even in rich countries.

Driving the news: The government helmed by Prime Minister Liz Truss announced a budget including extensive tax cuts, along with assistance for Britons facing soaring energy bills this winter.

  • The package was bigger than analysts expected, amounting to about 1.4% of U.K. GDP, according to JPMorgan. For comparison, the additional spending next year included in the Biden administration's signature climate and health care package is expected to be more like 0.14% of U.S. GDP.
  • The prospect of higher deficits led to soaring rates on U.K. bonds, with the five-year yield rising by nearly half a percentage point, to 4.02%. It was the biggest single-day move on record, according to Bloomberg.
  • That coincided with the pound plunging on currency markets to $1.09 as of 11:55am EDT, its lowest against the dollar since 1985.

Between the lines: Normally, when leaders of an advanced country like Britain tilt toward more expansionary fiscal policy, the effect is higher interest rates but also a surging currency, as investors seek to take advantage of surging growth and those higher rates.

  • That, for example, is what happened after former President Trump's surprise victory in the 2016 election. The sense that the U.S. would cut taxes — leading to larger deficits — under his leadership fueled a 6% rally in the dollar index over the ensuing weeks.
  • That pattern we're seeing in Britain — of higher rates and a weaker currency — is what you expect to see in countries where investors lack confidence in the governance institutions to prevent deficits from spiraling out of control and fear the value of their bonds will be inflated away, or worse.
  • This will step up pressure on the Bank of England to raise rates even more than had been planned, as the fiscal stimulus and weaker pound will tend to worsen inflation. That, however, also makes a recession more likely.

Meanwhile: Decisions by the new government to fire the top civil servant at the British Treasury and to release this fiscal plan without the traditional process of review from an independent fiscal agency are also contributing to a sense that economic policymaking has gone awry in the world's sixth-largest economy.

What they're saying: The U.K. government "is driving ahead with extraordinary, even reckless ambition" in its fiscal policy, wrote Krishna Guha and Peter Williams of Evercore ISI in a client note.

  • "[I]t is running a very high stakes experiment as to where binding market fiscal constraints lie for a developed economy with its own central bank, large domestic financial system and domestic currency debt."

Flashback: Around 2010, there was a lot of discussion of "bond market vigilantes," the supposed role that financial markets play in punishing any country that displayed insufficient fiscal rectitude.

  • It became a sort of punchline, and in hindsight wasn't the right lens to apply to a country like the United States at that time of insufficient output and too-low inflation. But now we're seeing what bond vigilanteism really looks like in Britain.
  • It's a reminder that the economic conditions of that era really were the opposite of those in this era. The problem then was insufficient global demand; now it's one of insufficient global supply.

The bottom line: The era in which policymakers had a free lunch when considering policies to stimulate their economy is over, as bond and currency markets are telling the British government loud and clear.

2. 💷 Currency transition

Photo: Jim Dyson/Getty Images

The U.K. has another currency headache: In the coming days, millions of the paper £20 or £50 bank notes still in circulation will no longer be legal tender.

  • The result is lengthy lines at the country's central bank — one way Britons are swapping these notes for polymer ones.
  • As of Sept. 30, shops and businesses will only accept the updated notes.

Where it stands: The majority of paper notes have been withdrawn from circulation. The Bank of England says roughly £11 billion worth of paper notes (about $12 billion) need to be spent or exchanged for the new tender before next week's deadline.

Catch up quick: Polymer currency was first introduced in 2016, starting with the £5 note. Among the changes: Economist Adam Smith is no longer featured on the £20 note. He's been swapped for artist J.M.W. Turner.