Britain facing a dual crisis and could be ill-equipped to cope

He said: “Britain is facing a twin crisis. An economic crisis that causing anxiety for millions of households and a financial crisis that has too many parallels with 2008-09.

“The Bank of England has been keen to point to the war in Ukraine as the primary cause of the current inflation, but they have also highlighted two other factors: labour supply shortages and post-pandemic supply chain disruption.

“The ONS reported this week that a record number of people – 2.5 million – were economically inactive because of long-term sickness. Add in the Institute of Employment Studies’ report earlier this year that there were 1.1 million fewer people in the labour force than would have been expected on pre-pandemic trends and it is clear why so many employers are reporting difficulties in filling vacancies.

“This can help to fuel inflation. But is also clear that policies to increase healthcare – in terms of occupational, physical and mental health – may be more effective supply-side policies than the trickle-down economics proposed by the current government.

“The mini-budget which announced those policies exposed a key weakness within the financial system. The lack of OBR economic forecasts to accompany the mini-budget and the Treasury and the Bank of England appearing to be pulling in opposite directions caused major problems for sterling as its value plummeted.

“It also caused the value of UK government bonds to fall as fears over the government funding deficit rose. That is when the role of Liability-Driven Investments (LDIs) became important and forced the Bank of England to act.

“LDIs use derivatives to generate the shortfall in cash that pension funds may need to make their monthly payouts to pensioners. They are a type of insurance contract against unexpected moves in markets. With interest rates, and yields on government bonds, having been so low since the last financial crisis, the cash from these LDIs have been used by asset managers to secure higher returns on more risky assets. A form of leveraged bet, which has parallels with CDOs prior to the 2008-09 Financial Crisis.

“They are important as the value of these LDIs has quadrupled over the last decade. When the fall in bond yields caused asset managers to scramble to find the cash to cover their LDI-related derivatives, there was a real danger of some pension funds collapsing. The Bank of England was forced to intervene. Instead of its previous policy of trying offload its holding of government bonds, it was forced to buy them.

“This is a failure of regulation and foresight that is reminiscent of the years before the 2008-09 Financial Crisis. That crisis had a huge impact on the economy and austerity was a price that the public paid for many years thereafter. Given the current cost of living crisis, we are very ill-equipped to pay for another financial failure.”