- The drop in the pound and the loss of confidence in policy makers is part of a larger paradigm shift, Mohamed El-Erian said.
- The economist reiterated that the era of high-liquidity and low-interest rates was over.
- But it could be painful for economies to dig themselves out of overly-iquid conditions, possibly resulting in stagflation.
The swift drop in the value of the pound against the dollar and the loss of confidence in UK policy makers is a historic moment – and points to a larger paradigm shift in global financial markets, Mohamed El-Erian said on Wednesday.
The top economist pointed to volatility spurred by the UK’s new budget plan, which involves cutting taxes for the wealthy and slashing planned corporate tax hikes. It caused the pound to plunge to a 37-year-low on Friday, and to sink another 2% on Monday, with analysts projecting that the UK currency could sink below parity with the dollar next year.
The plan was criticized on Wednesday by the International Monetary Fund, which gave a stinging assessment of the new “mini-budget” for its focus on cutting taxes at a time of sky-high inflation. Unfunded tax cuts and increased debt will cause further harm, economists say, and the Bank of England could be forced to hike rates more aggressively than planned and increase the risk of a recession.
“It is amazing that this is a G7 country, that over the last six days, has experienced disorderly moves in the currency and in bond yields, a loss of confidence in policy making, now, direct, central bank intervention, and an IMF warning.” El-Erian said on an interview with CNBC.
“That normally happens in a developing country. It does not happen in a G7 economy. So this is historic. It points to the paradigm shift we’re going through and the fragility of markets,” he added.
El-Erian has previously warned markets of the paradigm shift, pointing to central banks’ pivot from quantitative easing to quantitative tightening as inflation continues to climb. That means that the era of high-liquidity and ultra-low interest rates is over – and exiting that regime could result in stagflation, hammering the global economy with of high inflation, high unemployment, and low growth.
“The longer you stay in this la-la-land of [quantitative easing], floored interest rates, dislocated markets, funny interventions, distorted asset allocations, the longer you stay in, the harder the exit. And what we’re seeing [in the UK] is that the exit is really complicated,” El-Erian said.
To combat the potential for higher inflation, the UK will have to hike interest rates to keep inflation under control. But that could also cause enormous financial pain to households, causing unemployment and floating mortgage rates to skyrocket.
It demonstrates the competing paths of the UK’s fiscal and monetary policies, and it’s critical that the US avoids a similar situation, El-Erian said. He has previously criticized the Fed for not acting on inflation sooner, but has recently urged the central bank to continue hiking rates to bring down runaway-inflation, despite the possibility of slowed growth and high unemployment.