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Britain is not Italy

21 October 2022

After just 45 days in office, Liz Truss, the unpopular British Prime Minister, resigned after pushing an unfunded budget that sent the Sterling plummeting and Gilts yields sharply higher. The budget, which had seemingly not been reviewed by the government’s fiscal specialists or the Bank of England, met a market hungry for clear macroeconomic solutions. The result was a crisis that forced Truss out of office in what proved to be the shortest tenure of any Prime Minister in British history.

Is Britain’s situation akin to Italy’s ?
There are some similarities between the UK’s current challenges and Italy’s. The two countries share a series of vulnerabilities:

  • 1. Political instability comes when too little growth is being shared very unevenly across the population leading to governments strongly favoring one group over others without a sense of a national social contract. This can happen when there are strong regional/identities disparities (e.g. countryside versus greater London), strong wedge issues that leave few swing votes and when people begin to form culturally segregated groups with conflicting news streams (e.g. Daily Telegraph and Mirror versus the Guardian). That said, it’s important to note that there is a large swath of swing voters in the UK. Time will tell what happens with the next Prime Minister (possibly the moderate Rishi Sunak or Penny Mordaunt), but the UK is unlikely to make the same mistake it did with Truss. Instead, the strategy for generating growth will likely be through reforms not tax cuts for the wealthy, as Conservatives are far behind in the polls.
  • 2. The second element of comparison with Italy is a high government debt level (96% vs Italy 150% ) but it is far from critical levels and Gilts are likely to rally as investors risk appetite improves. Part of the rise in Gilt yields is a perceived sense that the Bank of England needs to tighten more faced in part with a weak currency, rather than an acute credibility crisis. High leverage in LDI strategies used by pension funds accentuated the demand for Gilts.
  • 3. Finally, in both cases, the level of growth is too low especially faced with the cost of climate change. This suggests Italy and Britain face difficult reforms ahead.

What does it mean?

For governments looking at the UK, it is no surprise that good governance and dealing with the high costs of the energy crisis are a priority. It is also a reminder that progress is easier when society is unified—which is not fully the case in the European Union. The current political climate suggests central banks will, when they can, maintain as easy a monetary policy stance as possible. That tends to favor holders of equity and credit in the long-run.

 

Source: Pixabay

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