Truss has now put the country on an economic path completely at odds with most, if not all, of the world’s major economies.
Hannah McKay | Reuters
LONDON — Britain’s new Prime Minister Liz Truss may have spoken extensively about “spillover economics” during her election campaign this summer, but no one could have predicted the panoply of tax cuts triggered just weeks after his tenure in Downing Street.
Touted as a ‘mini-budget’ by his finance minister, Kwasi Kwarteng, Friday’s budget announcement was anything but a volume of tax cuts not seen in Britain since 1972.
Truss – whose “Trussonomics” policy stance has been compared to that of his political idols Ronald Reagan and Margaret Thatcher – has now set the country on an economic path completely at odds with most, if not all, of the world’s major economies, as inflation boils over and a cost-of-living crisis sweeps across Europe.
It was seen, even by some of his supporters, as a political and economic gamble with Truss yet to face the wider British electorate in a national vote – unlike his predecessor Boris Johnson.
Market participants immediately predicted that Britain would have to increase its bond issuance and dramatically increase its debt to pay for the cuts – not typical of low-tax Conservative governments of the past.
UK bond markets tumbled on Friday as investors shunned the country’s assets. Yields (which move inversely to prices) on the 5-year gilt rose half a percentage point – which Reuters said was the biggest one-day rise since at least 1991.
And with collapsing bonds, sterling was also sent into a tailspin after hitting 37-year lows against the dollar those last weeks. It ended Friday down almost 3.6% against the greenback. Over the week it has lost 5% and is now down 27% since just before the 2016 Brexit vote.
Wall Street banks are now seriously considering a break below parity with the US dollar – for the first time in history – and many commentators have likened the pound to an emergency market currency.
The left-leaning The Guardian called it a “budget for the rich” on its front page on Saturday, while The Times called it a “big tax gamble”. The right-wing Daily Mail called it a ‘true Tory budget’ while Kwarteng himself said it was a ‘very good day for the UK’, declining to comment on currency movements.
ING analysts said in a research note that investors are concerned that the UK Treasury has effectively pledged to borrow indefinitely for these tax cuts, and that the Bank of England will have to respond with tax hikes. more aggressive rates.
“For us, the magnitude of the rise in gilt yields has more to do with a market that has become dysfunctional,” ING senior rates strategist Antoine Bouvet and global head of markets Chris Turner said in the note. .
“A number of indicators…suggest that liquidity is drying up and market functioning is impaired. A signal from the BOE that it is willing to suspend gilt sales would go a long way to restoring market confidence. market, especially if it wants to maximize its chances of fighting inflation with conventional tools like interest rate hikes. [quantitative tightening] In short, the battle is not worth fighting for the BOE,” they added, referring to the Bank’s decision to normalize its balance sheet after years of stimulus.
ING also noted that the UK’s long-term sovereign outlook is currently stable with the three major ratings agencies, but the “risk of a possible shift to a negative outlook” could arise when they are revised (21 October and December 9).
Deutsche Bank analysts said, meanwhile, that “the price of accommodative fiscal policy was laid bare by the market” on Friday.
“[Friday’s] market movements suggest there may be a lack of credibility,” Sanjay Raja, senior economist at Deutsche Bank, said in a research note.
“A plan to restore public finances will be necessary but not sufficient for the markets to regain confidence in an economy with large twin deficits. [the U.K.’s fiscal and current account balances],” he added.
“Essentially, with fiscal policy moving into easier territory, it may now fall to the Bank of England to stabilize the economy, with the MPC [Monetary Policy Committee] have more work to do to bridge the gap between expansionary fiscal policy and tight monetary policy.”
– CNBC’s Karen Gilchrist contributed to this article.