The Bank of England needs to hike rates by a super-sized 100 basis points to calm markets shaken by UK tax cuts, Mohamed El-Erian says

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Mohamed El-Erian has called on the Bank of England to raise UK interest rates by one full percentage point to soothe markets spooked by the government’s plan for big tax cuts. 

The British pound sank to a record low of $1.035 against the US dollar on Monday after Chancellor Kwasi Kwarteng, the UK’s finance minister, last week laid out a debt-financed package of tax cuts worth 45 billion pounds ($48.5 billion). He doubled down on the tax plans on Sunday, saying, “There’s more to come.”

Economists, lawmakers and strategists now believe the BOE will be forced to intervene with an emergency interest-rate increase to calm nerves.

Speaking on BBC’s “Today” show, El-Erian laid out his thinking on what the BOE’s governor, Andrew Bailey, should do.

“If I were the governor, and the chancellor is not modifying his plan, I would increase interest rates. And not by a little — by 100 basis points, by one full percentage point, to try and stabilize the situation,” the top economist said Monday.

Investors dumped the pound thanks to concerns that could fuel already red-hot UK inflation and heavily increase teh government’s debt burden, which threaten to damage the country’s already struggling economy.

Sterling fell by as much as 4.7% in Asian trading hours to $1.0350, its lowest level since 1971, when the UK switched to a decimal-based currency system. 

Economists have labelled the government’s planned tax cuts as fiscally irresponsible, given the UK is facing a cost-of-living crisis driven by high levels of inflation. 

Kwarteng should be “paying really close attention, because if he’s not careful, what’s happening in markets could snowball and undermine what he’s trying to do,” El-Erian said.

The economic adviser to Allianz laid out what a continued fall in the pound could mean for consumers. He said their purchasing power will erode, and they will become more insecure about their future income. Also, the money they have in financial markets will be under threat, he said.

“You get what economists call a negative income effect,” he said. 

In El-Erian’s view, Kwarteng has two options that could return stability to markets. “Choice number one is he recalibrates his package — politically difficult, but economically needed,” he said. 

“Choice number two is he leaves it to the Bank of England. And in that case, the Bank of England would have to hike in an emergency meeting, because they don’t meet again until November.”

The UK central bank raised interest rates by 50 basis points just last Thursday and isn’t scheduled to meet again until November 3. But the BOE can hold an emergency gathering in exceptional circumstances — though El-Erian said this is not a good-looking option for Bailey.

“That in itself goes against him,” he said. “Again, the image is of driving a car, with the chancellor foot on the accelerator and the governor’s foot on the brake. That is not a good way to drive the UK economy.”