Truss has now set the country on an economic path that is completely at odds with most, if not all, of the major global economies.
Hannah Mckay | Reuters
LONDON – New British Prime Minister Liz Truss may have talked a lot about ‘trickle-down economics’ during her campaign this summer, but no one could have predicted how many tax cuts she would unleash just weeks into her Downing Street tenure.
Friday’s tax announcement, heralded as a “mini-budget” by her finance minister Kwasi Kwarteng, was anything but with an amount of tax cuts not seen in Britain since 1972.
Truss – whose ‘Trussonomics’ policy stance has been compared to that of her political idols Ronald Reagan and Margaret Thatcher – has now set the country on an economic path that is completely at odds with most, if not all, major world economies now that inflation is rising. boils over and a cost of living crisis is sweeping Europe.
It is seen, even by some of her proponents, as a political and economic gamble with Truss not yet facing the wider British electorate in a rural vote – unlike her predecessor Boris Johnson.
Market players immediately predicted that Britain would have to scale up its bond issuance and significantly increase its debt burden to pay for the austerity measures – not typical of the low-tax Conservative governments of the past.
UK bond markets spiraled downward on Friday as investors eschewed the country’s assets. Yields (moving inversely with prices) on 5-year Treasuries rose half a percentage point — the largest single-day rise since at least 1991, according to Reuters.
And as bonds slumped, the pound also went into freefall after hitting a 37-year low against the dollar in recent weeks. It ended Friday nearly 3.6% lower versus the greenback. During the week, it lost 5% and is now 27% lower since just before the 2016 Brexit vote.
Banks on Wall Street are now seriously considering a breach below par with the US dollar – for the first time in history – and many commentators have compared the pound to a market emergency currency.
The left-wing newspaper The Guardian called it “a budget for the rich” on its front page on Saturday, while The Times called it a “big fiscal gamble”. The right-wing Daily Mail newspaper called it a “true Tory budget”, while Kwarteng himself said it was a “very good day for the UK”, and declined to comment on currency movements.
ING analysts said in a research note that investors are concerned that the UK Treasury has now effectively committed to open-ended loans for these tax cuts, and that the Bank of England will have to respond with more aggressive rate hikes.
“For us, the magnitude of the increase in gold yields has more to do with a market that has become dysfunctional,” ING’s Senior Rates Strategist Antoine Bouvet and Global Head of Markets Chris Turner said in the note.
“A number of indicators… suggest liquidity is drying up and market forces are being affected. A signal from the BOE that it is willing to suspend sales of gold would go a long way towards restoring market confidence, especially if it its chances of fighting inflation with conventional instruments such as rate hikes [quantitative tightening] in short, it’s not worth fighting for the BOE,” they added, referring to the Bank’s move to normalize its balance sheet after years of stimulus.
ING also noted that the long-term outlook for UK government bonds is currently stable across the big three rating agencies, but the “risk of a potential shift to a negative outlook” could come when revised (October 21 and December 9).
Deutsche Bank analysts, meanwhile, said the “price of a simple fiscal policy was exposed by the market” on Friday.
“[Friday’s] market movements suggest there is a credibility gap,” said Sanjay Raja, senior economist at Deutsche Bank, in a research note.
“A plan to put public finances on a sustainable basis will be necessary, but not sufficient to allow markets to regain confidence in an economy with large double deficits. [the U.K.’s fiscal and current account balances],” he added.
“It is critical that as fiscal policy moves into simpler territory, responsibility can now fall on the Bank of England to stabilize the economy, with the MPC [Monetary Policy Committee] have more work to do to close the gap between expansionary fiscal policy and tightening monetary policy.”
— CNBC’s Karen Gilchrist contributed to this article.