The reaction of financial markets to Friday’s UK mini-budget has been swift and brutal. Sterling has fallen, particularly against the US dollar, and the cost of borrowing for the UK government has risen sharply. Markets are betting on further Bank of England interest rates increases – on Monday the bank said it would act as needed at its next meeting, but did not announce an immediate rate rise.
The credibility of UK economic policy has been called into question by the mini-budget, which is both slashing taxes and promising massive new spending in response to the energy crisis. The resulting rise in the budget deficit will require more borrowing, raising questions about the sustainability of the public finances. Chancellor Kwasi Kwarteng is betting that the tax cuts will boost economic growth, but investors are dubious.
A longer-term loss of market confidence would bring significant costs in terms of government flexibility to manage the economy. The outlook for the UK economy, already seriously damaged by Brexit, could worsen. Normally a lower currency value helps exporters, but UK businesses now face post-Brexit barriers in EU markets.
The links between the Irish and UK economies have diminished over the years, but are still significant. The fall in sterling against the euro, while less than its drop against the US dollar, will make life harder for Irish exporters to the UK. On the flip side, those crossing the border to shop in Northern Ireland will find their euro goes further.
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Perhaps the most important message, ahead of Tuesday’s Irish budget, is that financial markets are again closely watching what countries do, as the Covid-19 era of cheap borrowing ends.
Ireland’s economic position is different than the UK , with the budget in surplus – and likely to stay that way, even with the measures to tackle the energy crisis. Nonetheless the message sent out by the Budget needs to be one of stability and a credible plan for the public finances. There should be enough resources in place to respond to the immediate crisis – and to leave scope to adjust to circumstances next year if needed.