The chance of a U.K. sovereign default is small thanks to the fact that the U.K. has its own currency and thus can monetise its fiscal deficits as it already has.
Yet there are side effects to this strategy, which are on the way, according to Nouriel Roubini:
“I am worried about the hung parliament. Whenever you have divided, weak or multi-party governments, budget deficits tend to be higher. It is harder to make the necessary sacrifices.”
“Eventually inflation will go up and that erodes the real value of public debt,” Roubini says. “In that scenario the value of the pound will fall sharply. It could even become disorderly and that could damage the economy, the financial markets and also the role of the pound as a reserve currency.”‘
Still, it’s better than having the risk of outright default as nations such as Greece or Portugal have due to their use of a shared currency. Mr. Roubini might also be proved wrong on the U.K. front should deflationary forces in the U.K. economy keep inflation in check in the near-term, and the government gets its fiscal house in order before inflation gets worse.
Nevertheless, we have to admit that the latest inflation data out of the U.K. has been worrisome and argues in Roubini’s favour.