Two rabbits running in opposite directions of high inflation and recession are seriously testing each country’s financial and fiscal policies. There are many interpretations that what triggered that signal was the fall of the British pound. This is because, although monetary policy tightening is inevitable to keep up with high inflation, fiscal policy support is needed to prevent the economy from sinking to recessionary levels.
The fall in the value of the pound, which shocked financial markets around the world, ended with the UK government withdrawing tax cuts for high-income families. The pound recovered some of its losses, and bond markets in major countries showed relief. On the 3rd (local time), prime government bond yields fell (the value of the bond rose). The yield on the UK government’s 10-year bond fell 0.20 percentage points to 3.95%. The yield on the 10-year US Treasury bond also fell to around 3.64%, 0.18 percentage points lower than the previous one. On the 26th of last month, the value of the pound, which had fallen to the level of $1.03 per pound, recovered to a level of $1.13 per pound.
It was affected by the announcement the day before in the UK that Finance Minister Quazi Quateng had announced that he would withdraw his plan to reduce the top tax rate for high income earners from 45% to 40%. The portion of the policy to scrap the top income tax rate accounts for around £2 billion (3 trillion won) of the £45 billion (72 trillion won) tax cuts recently announced by the government the UK.
The tax cut announced by the British government on the 23rd of last month was intended to support economic growth, but the market’s reaction was the exact opposite. There was widespread concern that the tax cut policy would have the effect of supplying liquidity, fueling inflation, and issuing large-scale government bonds to compensate for the shortfall in tax revenue. After the announcement of the tax cut policy, the pound fell to an all-time low of $1.03, and as the value of British government bonds plummeted, rumors of a financial crisis emerged from the UK.
Regarding the current situation, the Financial Times said, “The recent high volatility in the global government bond market is mainly due to the wrong policy experiment of the UK government, but the US and other countries are having difficulty coming find the optimal policy combination between high and low inflation. We share the risk of failure.” As it is difficult to find a balance between the austerity policy to contain high inflation and the expansionary fiscal policy to prevent economic recession, a similar phenomenon may occur in other countries.
Rabobank strategist Richard Maguire told the Financial Times: “This is a case that the UK has brought on alone, but the same pressure is being felt in other countries as well. “I’m curious if this will happen,” he said.
The situation is no different in Korea, which has recently suffered from a persistent trade deficit and a sharp increase in the exchange rate.
Park So-yeon, a researcher at Shinyoung Securities, said, “In the past, it was assumed that the government would take preemptive measures when the economy was struggling. He also found it difficult to use easily,” he said. “This suggests that we need to give up our expectations about policy, unlike in the past,” he said.
Regarding the recent outright purchase of government bonds and government bond buyback (early redemption) by the Bank of Korea and the government, Park said, “I have heard that there is a high possibility that inflation will intensify further,” he said. On the 28th of last month, the Bank of Korea and the Ministry of Strategy and Finance announced a simple purchase of 3 trillion won government bonds and an emergency purchase of 2 trillion worth of government bonds as interest rates on bonds’ the government increased. It was a measure to stabilize government bond yields by collecting bonds from the market, but as a result, 5 trillion in liquidity was supplied to the market.
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