Why Bank of England had to step in to save the Britain from an economic crisis?

UK crisis

Global Market
by 5paisa Research Team Last Updated: 2022-09-30T18:58:53+05:30

This week, an extremely shocking incident took place in Britain. The Bank of England, which is independent of the government had to intervene forcefully to stop an economic crisis in the country.

Its central bank quoted,

“Were dysfunction in this market to continue or worsen, there would be a material risk to U.K. financial stability,”

So, what is exactly happening in the UK? 

Well, things have been pretty bad in UK lately. It all started with its divorce from the Eroupean union (BREXIT). UK relies heavily on EU for food and labor. It imports 45% of its food items and most of it comes from the EU. Post the BREXIT, governments introduced custom and other fees for trade between the borders. 

According to a report by Bloomberg, the cost of moving a truckload of items to the U.K. from Italy, for example, costs nearly 25% more than before the split from the EU.

All the additional costs are passed on to the consumers, due to which the food prices have risen drastically in the UK.

To add to the woes, the Russia-Ukraine war happened, which rose the energy prices in the nation! As per a report, the energy prices in the UK would rise by 80% from the next month. 

All of these factors together led to soaring food and energy prices and sky-high inflation in the country. The inflation in the UK has risen to an eye-popping 9.9%.

Amidst all the chaos, the UK voted Liz Truss, to be their new prime minister and entrusted her with the responsibility of tackling one of the worst economic crises in history.

Liz had a draconian task at hand. On one side, the inflation in the nation was flirting with new peaks, on the other hand, the average pay and the disposable income of the people in the country were decreasing. As per a report, In August the average household’s disposable income had dropped by 16.5% and with fewer bucks in hand,  two of five people said that they are cutting down on eating out, traveling, and socialising outside the home.

It was a rock and hill choice for Liz, if she had to combat the inflation, she would have to increase the interest rates, so that people had less money in hand, they spend less and the prices of goods come down. On the other hand, if she had to increase the wages, and kickstart the economy, then people would need more money in hand.

Liz choose the latter one and introduced a growth plan to stimulate the economy. Under the plan, she introduced tax cuts. The tax rate on an individual's earnings of more than £150,000 a year would go from 45% to 40%. Meanwhile, they reduced the lowest tax rate from 20% to 19%.

Also, they did away with their plan to increase the corporation tax. They also capped the energy prices, so that people have would more disposable income. The government believed that all these measures would put more money in the hands of the people and would bring back the economy on wheels.

Well, all these measures would cost the UK government anywhere between  £41bn to £45bn over the next five years. This decision by the government spooked the investors as they believed these plans would further increase inflation in the nation and the government would have to borrow billions to fund these plans. 

Investors started dumping the government bonds and the British pound! Due to this, the pound fell to its historic low and the yield on the U.K. government’s debt soared. For instance, yields on 10-year government bonds have risen 325 percent this year. The exorbitant rise in yield made it much more expensive for the government to borrow!

Remember, we told you the Bank of England stepped in to stop the crisis, they said they would buy long-term government bonds to stabilize the market. Seems like, the government's decision to go all aggressive, could have some severe consequences on the economy.

Well, it's only time to tell if Liz’s plan will bring back the economy on track or will derail it! 

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