'A global recession is ever more likely': What does the UK meltdown mean for us?

Thursday, 29 September 2022

If you’ve been worried by a fall in the New Zealand dollar this week, spare a thought for anyone you know in Britain.

On the back of intense financial markets turmoil, the British pound fell to almost equal the US dollar this week – hitting its lowest point since the 1980s – and there were even concerns that some giant pension funds were at risk of collapse.

The Bank of England was forced to take emergency action to head off a crisis.

So what’s happening, and what does it mean for New Zealand?

* UK central bank intervenes in market to halt economic crisis

* Government debt is becoming less of a big deal

A newspaper poster blares more of the grim economic news confronting the UK.

As far as new prime ministers go, Liz Truss has made her presence felt in Britain.

Her new Chancellor of the Exchequer, Kwasi Kwarteng – he’s the equivalent of our Finance Minister – revealed a mini-budget on Friday. It included £45 billion of tax cuts, particularly for the well-off, no clearly identified reduction in spending, and an extra £70 billion in government borrowing to help people struggling with the country’s soaring power bills.

That spooked investors, worried about the financial health of the economy, who started to shift their investments to other countries.

The currency plummeted and the value of long-dated government bonds tumbled, while the implied yield (the return on investment to a bond holder) shot up – making government borrowing more expensive, as well as reducing the value of the investments for those who already hold them.

There were even concerns that what was under way was a “dynamic run” similar to what was seen when English bank Northern Rock went under at the start of the Global Financial Crisis.

British Prime Minister Liz Truss is facing a major economic crisis only weeks after taking office.

Pension funds, which are big investors in long-dated government bonds, were in trouble, with some potentially needing to prop up their investments to such an extent that there were worries they could collapse.

That prompted the Bank of England to say it would buy long-term government bonds to stop the slide in asset prices. It will buy bonds at a rate of up to £5 billion a day for almost two weeks.

What does it mean for us?

Sharon Zollner says there’s a growing realisation central banks aren't coming to the rescue.

In terms of direct investment and trade implications, New Zealanders are relatively well protected.

Only about 2% of our total exports and imports are with Britain, and most managed funds only have a small portion of their investments in the UK.

KiwiSaver manager Rupert Carlyon says most managers will also be currency hedged, which means they are protected against movements in the currency. He said it would be a different question if the US was on the slide.

Infometrics chief forecaster Gareth Kiernan says there might be more concentrated effects in areas where Britain is a bigger part of trade, such as wine, where the UK is 22% of exports, and sheep meat, where it is 10%.

“The combination of the weaker pound and potential downturn in British household spending could have a noticeable effect on demand and pricing for these products, although given the state of the broader world economy, it might also be difficult to disentangle the UK effects from everything else that is going on at the moment.”

The UK’s new Conservative government has had a hard lesson in the limitations of fiscal policy.

Kiernan says more people might want to migrate from Britain to New Zealand if their outlook is bleak.

“In 2018, migrant arrivals from the UK made up 8.4% of total migrant arrivals, of which just over 60% were non-NZ citizens.”

But there’s a bigger problem

The bigger issue is that this sort of problem in the world’s economy can be contagious.

ANZ chief economist Sharon Zollner said there was already risk aversion, and share prices were already lower around the world, in response to a growing realisation that central banks were not going to “ride to the rescue” of struggling economies.

“What the UK situation has shown is that fiscal policy also has limits. Even if you’re the prime minister, you can’t just decide to hand out as much money as you like, because the market will ask who is going to fund that and at what interest rate.

“It’s another nail in the coffin of the everlasting hope that someone is going to stop bad things happening. Bad things are happening. A global recession is looking ever more likely.”

She said, as a small trading nation, New Zealand was exposed, particularly to China.

But she said the country was in a good position because it sold food and there were factors keeping food prices up.

Westpac senior economist Satish Ranchhod said there was a risk that the UK situation could “reverberate” more broadly.

As uncertainty pushed down the NZ dollar, it added to inflation pressure.

It meant interest rates would have to go higher than they might have otherwise, he said.

“The volatility in financial markets and the drop in the New Zealand dollar are really adding to inflation pressures and will cause ripple effects to the New Zealand economy,” Ranchhod said.