Macroeconomic Suez

Market forces have proved too strong for the UK’s supply-side, trickle-down experiment. The new Chancellor of the Exchequer has re-set British fiscal policy even if we will have to wait until the end of the month for full details. The next 2 weeks are thus crucial. as investors wait for the final cut of the budget bill amid lingering political instability. The change of tone with the arrival of Jeremy Hunt may suffice to appease the “bond vigilantes” for now, allowing the Bank of England to keep the tap off direct bond market intervention. If pressure lingers, the bar for a resumption of BOE intervention is now probably lower since the moral hazard issue is less acute.

The whole episode could be seen as the natural consequence of “hard Brexit”, with unfunded tax cuts and supply-side reform the sole politically palatable option remaining given the cost of high trade friction with the EU, only to crash against financial reality. The Suez operation in 1956 is a “founding trauma” for modern Britain, as it discovered it was no longer a “Great Power”. This month’s fiscal drama could convince the UK authorities that their capacity to steer a lone path on economic matters is small. Perhaps the silver lining around this cloud is that a re-assessment of the U. K’s relationship with Europe could start. October 2022 may have marked “peak Brexit”.

The issue with the UK pension funds is raising questions on the next potential sources of financial instability. The steep increase in corporate refinancing gaps must be monitored. Fortunately, businesses have taken advantage of the low interest rate period to lengthen the maturity of their debt, which gives time to absorb the shock. Yet, the tightening in broad financial conditions will hurt growth. Central banks are however ready to take risks to break the back of inflation. While the “reawakening of the doves” continues on both sides of the Atlantic, it is not for immediate consumption. For now, the signal from the current dataflow – e.g., the higher-than-expected US core inflation in September – is stronger than the more prudent message from the models.