UK base interest rate over 6% next year?…Central Bank Chief says "Significant response needed to tax cut plan"

Bank of England [Photo by Reuters-Yonhap News]

[Asia Economy Reporter Park Byung-hee] Following the sharp decline in the British pound and government bond prices, the turmoil in the UK financial market continues, with forecasts suggesting that the UK base interest rate, currently at 2.25%, could rise to the 6% range by May next year.

According to major foreign media on the 27th (local time), the UK futures market is even predicting that the UK base interest rate will rise to 6.25% by May next year. This means the UK base interest rate could nearly triple in a short period.

This is because Huw Pill, Chief Economist of the Bank of England (BOE), stated that significant monetary policy responses would be necessary due to the government's large-scale tax cut policy. He warned that if the large-scale tax cut policy stimulates inflation, the BOE may have to raise the base interest rate significantly.

The current consumer price inflation rate in the UK is 9.9%, the highest among the Group of Seven (G7) countries. In this situation, the UK Treasury announced on the 23rd a tax cut plan worth 45 billion pounds (approximately 69 trillion won), the largest in about 50 years.

Chief Economist Pill pointed out that the government's large-scale expansionary fiscal policy could further exacerbate the already severe inflation.

The current base interest rate of 2.25% is the highest since the 2008 global financial crisis. If it rises to 6.25% as the futures market predicts, it will be the highest level in 25 years.

Following the UK government's tax cut announcement, the pound's value against the dollar fell to an all-time low, and UK government bond yields rose sharply, showing extreme turmoil in the financial market. On that day, the yield on the UK 10-year government bond rose by 0.26 percentage points to 4.5%, marking the highest level since 2008. The 30-year government bond yield exceeded 5% for the first time in 20 years since 2002. The previous day, the pound-dollar exchange rate hit 1.03 dollars per pound, marking the pound's lowest value against the dollar ever.

In response, Chancellor Kwasi Kwarteng hurriedly announced on the 26th, when the pound hit its all-time low, that a medium-term fiscal plan would be unveiled on November 23 to manage the situation. Chancellor Kwarteng stated that he would revise current fiscal regulations and disclose plans to reduce the debt-to-GDP ratio within three years.

It is reported that there was a clash between Chancellor Kwarteng and Prime Minister Liz Truss during the announcement process of the medium-term fiscal plan. Sky News, citing UK government sources, reported that Prime Minister Truss initially judged that it was better not to respond to the market turmoil and opposed Chancellor Kwarteng's statement on the 26th. Although the long-time political allies Truss and Kwarteng clashed, Prime Minister Truss eventually followed Chancellor Kwarteng's opinion and announced the position to disclose the medium-term fiscal plan.

Chief Economist Pill suggested that the BOE has no intention of responding at the BOE monetary policy meeting scheduled for November 3. This is interpreted as waiting to see the Treasury's medium-term fiscal plan announcement on November 23.

Chief Economist Pill explained that in August, the BOE forecasted that the UK economy would fall into a long-term recession, reflecting the fact that the government had not prepared measures to protect households and businesses from rising energy prices at that time. Without government energy measures, the BOE would have no choice but to raise the base interest rate significantly to stabilize prices, reflecting the risk of an economic downturn. Pill explained that since the government announced energy measures last week, the changed conditions should be reflected.