El-Erian: U.K. market turmoil akin to developing country

The U.K. has behaved like a developing economy in response to the government's planned tax cuts, according to economist Mohamed A. El-Erian.

Speaking on a Twitter Spaces event hosted by Pensions & Investments Editor-in-Chief Jennifer Ablan on Thursday, Mr. El-Erian said recent events in the U.K. markets — "volatile markets, currency in a free fall, yields going up, loss of confidence in policymakers, a warning from the IMF" — is "typical of developing countries. It is not typical of a G-7" country. "That's important to remember, because what we are seeing here is absolutely extraordinary — it is historic," he said.

On Sept. 23, the new U.K. chancellor of the exchequer, Kwasi Kwarteng, announced a "mini-budget," which included a set of tax cuts and an energy price cap in efforts to stimulate growth.

U.K. gilt markets punished the announcement, with the yield on 10-year gilts soaring, closing that day at 3.83% and rising above 4% the following week. A month earlier, the yield was 1.86%.

The pound sterling dropped to $1.09 on Sept. 23, down from $1.22 a month earlier.

"The basic issue is inconsistent policies. If the new government had simply gone forward with the structural reforms to promote economic growth and with the energy stabilization, there wouldn't have been a negative market reaction," Mr. El-Erian said.

If the government were to delay tax cuts, although at political cost, "there is a path to restoring financial stability, albeit at lower growth … and at high inflation. If, however, the government cannot do that, then we are in for another round of instability," he warned.

The Bank of England stepped in on Wednesday to halt the chaos in gilt markets and alleviate risks to U.K. financial stability by announcing up to £65 billion ($74.2 billion) of long-dated government bond purchases.

There were sharp declines across the board on Wednesday "as the market digested the surprise announcement" from the central bank, he said.

The long-end of the curve is "protected, but the other yields are creeping back up and that's going to put the Bank of England in a really difficult position, because does it repeat its purchases and therefore go counter to its monetary policy objective or does it not do it and risk financial instability?" Mr. El-Erian added.

In the wide-ranging interview, Mr. El-Erian also said that liquidity risk "keeps me up at night," adding that "the U.K. is a reminder of when liquidity risk kicks in, you start getting these vicious cycles where the asset that is falling in price is sold more and more as people try to gain liquidity, or alternatively you get contagion."

He recalled that what made the taper tantrum of 2013 "so problematic is people couldn't sell what they wanted to sell. And when you don't sell what you want to sell, you sell what you can sell. And that means contagion," Mr. El-Erian said.