What the F is happening in the UK right now?!
30 September 2022
To understand the troubles last month in the UK, we have to first set the scene....
Like a lot of countries around the world post-COVID, the UK is experiencing super high levels of inflation, with the expectation it will get worse before it gets better. UK inflation is sitting at nearly 10% now, meaning a ton of goods and services are 10% more expensive than they were this time last year.
The Bank of England (BoE), like most Reserve Banks around the world, has the job of keeping inflation at around 2% a year. If inflation is higher, they have the ability to increase interest rates. If inflation is lower, they will reduce interest rates. The BoE has raised rates from 0.25% in 2021 to 2.25% today. This is a large and rapid move (what we call ‘monetary tightening’) and something the UK has not seen for decades!
This current environment is a tricky one. Bank’s around the world have a tough job, especially the BoE. The best way to think of this situation is to think of the UK like a house where one room – the economy room – is too cold and another – the inflation room – is too hot. But the heat pumps in the rooms have no individual controls. There is just one temperature dial so do you turn it up or down? Do you decrease the temperature in the inflation room (by increasing interest rates), which decreases economic growth? Or do increase the temperature in the inflation room (by decreasing interest rates), which increases economic growth?
The other issue is the UK's debt levels. Just like it’s bad for a company to have too much debt, it’s bad for a country too. Debt levels have risen over the last 30 years due to 1) the global financial crisis and 2) the Covid-19 pandemic. These are two major times when the Govt had to help out people through tax-cuts or one-off payments.
So when the Govt announced MORE tax-cuts, the world freaked out. Not only could this lead to higher debt for the UK (less revenue for the Govt b/c people are paying less tax but Govt spending the same/increasing) it also means inflation could go even higher (people have more money to spend more).
This led to the currency falling off a cliff. Just like when investors get nervous about the outlook of a company, they sell it's shares and the price falls - the same happens but at a country-level.
People, businesses and other countries are getting increasingly nervous around the ability for the UK to grow and so they have been taking their money (pounds) out of the UK leading to the currency falling.
A sudden and sharp drop in the pound creates uncertainty, throwing the plans of UK businesses that import and export goods into a fizz. They expect to pay a specific price for imports and get a certain price for goods and services they sell overseas. All that changes when the currency falls suddenly. If the pound is now worth less, the cost of importing goods from overseas goes up.
And the UK imports 50% of it's food....so the people of UK can expect some further pain...