Will the UK financial crisis lead to a larger crisis?

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Image Source: The Epoch Times

Recent financial crisis in the UK has caused waves of concern and selling among investors outside of the UK.

The sell-offs have increased concerns that the unrest in the UK could trigger a larger crisis as they coincide with high inflation, increasing interest rates, and the conflict in Ukraine.

Since there are indications that the government is rethinking parts of its plans, many analysts have stated that they anticipate the consequences to be relatively minor.

On Friday, the government fired Chancellor Kwasi Kwarteng and abandoned some tax cuts that had first caused the market upheaval. But the incident has brought attention to present-day financial threats.

Following Mr. Kwarteng’s promise of £45 billion in tax cuts in his mini-budget, which the government claimed would help rekindle economic development, borrowing costs in the UK spiked last month.

However, he did not mention how he planned to pay for them, alarming investors who were already concerned about the UK’s bleak economic outlook. So they quickly liquidated their holdings of UK government bonds and gilts.

Pension funds, massive investment companies that look after people’s retirement savings and frequently allocate a sizable portion to investments like government debt, showed some early signs of trouble in the UK.

Pension funds pleaded with the Bank of England for assistance as losses threatened to snowball, and the bank agreed to intervene immediately by stepping in and purchasing government debt. But, in the end, the Bank of England intervened thrice.

For the first time in over a decade, mortgage rates on standard two- and five-year fixed arrangements have risen to more than 6% due to the abrupt increase in borrowing costs, causing havoc in the UK housing market.

Analysts anticipate that the increase in mortgage rates will lead to a decline in home prices, which means that another investment frequently regarded as relatively safe is experiencing a substantial, quick change in value.

What impact has this financial crisis had on other nations?

Along with the UK’s, specific US and European government debt interest rates have increased.

And in response to the shifting market, UK companies have sold off some risky assets, having a ripple effect.

For instance, the Wall Street Journal noted that in the weeks following the UK decision, sales of collateralized loan obligations (CLOs), a term for bundles of corporate debt, increased. Some people already perceived that market segment to be rife with financial hazards.

What led to this?

Following Mr. Kwarteng’s promise of £45 billion in tax cuts in his mini-budget, which the government claimed would help rekindle economic development, borrowing costs in the UK spiked last month.

However, he did not mention how he planned to pay for them, alarming investors who were already concerned about the UK’s bleak economic outlook. So they quickly liquidated their holdings of UK government bonds and gilts.

The value of UK government bonds changed dramatically due to the sell-off. As a result, what is typically considered a stable, safe investment experienced tremendous volatility due to price declines and investor demands for a greater interest rate for maintaining a riskier investment.

Investment companies may change their holdings to account for losses and the increased risk resulting from that swing, which might have a significant impact.

Will this consequently lead to a global financial crisis?

IMF officials stated last week that as investors drawback, the amount of financial instability worldwide is approaching crisis levels.

The organization noted that the traditional banking systems in large economies like the US and UK have grown more resilient in response to rules implemented in the wake of the 2008 financial crisis. Thus, it did not predict a significant financial explosion.

Read Also: Kwasi Kwarteng u-turns on planned tax cuts 

However, emerging markets have more significant vulnerabilities, with the Fund estimating that 29% of banks face a financial risk in the case of a sharp, rapid decline.

Officials in the US and UK are particularly concerned about undiscovered issues in the vast “shadow banking” industry, where investors create and exchange debt products primarily out of sight of authorities.

Those mountains of debt may be under pressure when central banks worldwide hike interest rates.