Truss has now put the country on an economic path completely at odds with most, if not all, major global economies.
Hannah McKay | Reuters
LONDON – New UK Prime Minister Liz Truss may have talked a lot about the “trickle down economy” during her campaign this summer, but no one could have predicted the tax cut that was unleashed just weeks into his tenure in Downing Street.
Billed as a “mini-budget” by his Finance Minister Kwasi Kwarteng, Friday’s tax announcement was anything but with a volume of tax cuts not seen in Britain since 1972.
Truss, whose political stance “Trussonomics” 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 major world economies as inflation rises and a cost-of-living crisis enters Europe.
Even some of his supporters have seen it as a political and economic gamble with Truss not yet facing the wider British electorate in a national vote, unlike his predecessor Boris Johnson.
Market players immediately predicted that Britain would have to increase its bond issuance and significantly increase its debt load to pay for the cuts, which is not typical of low-tax Tory governments of the past.
UK bond markets plummeted on Friday as investors shunned the country’s assets. Yields (which move inversely to prices) on 5-year gold rose half a percentage point, which Reuters reported was the biggest one-day increase since at least 1991.
And with bonds falling, sterling was also sent into freefall after hitting 37-year lows against the dollar in recent weeks. It ended Friday down nearly 3.6% against the greenback. It lost 5% for the week and is now down 27% since shortly before the 2016 Brexit vote.
Wall Street banks are 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.
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 called it a “genuine 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 committed itself to an open-ended loan for these tax cuts and that the Bank of England will to respond with more aggressive rate hikes.
“For us, the magnitude of the jump in gold yields has more to do with a market that has become dysfunctional,” said ING senior rates strategist Antoine Bouvet and global head of markets, Chris Turner, on 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 in restoring market confidence, especially if it wants maximize their chances of fighting inflation with conventional tools such as interest rate hikes [quantitative tightening] The battle is ultimately 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 UK’s long-term sovereign outlook is currently stable with the three major rating agencies, but the “risk of a possible shift to a negative outlook” could come when they are revised (21 October and December 9).
Analysts at Deutsche Bank, meanwhile, said the “price of easy fiscal policy was exposed by the market” on Friday.
“[Friday’s] market movements suggest there may be a credibility gap,” Sanjay Raja, senior economist at Deutsche Bank, said in a research note.
“A plan to make public finances sustainable will be necessary, but not sufficient, for markets to regain confidence in an economy with large twin deficits. [the U.K.’s fiscal and current account balances],” added.
“Crucially, with fiscal policy shifting into easier territory, the onus may 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 monetary policy tightening.”
—CNBC’s Karen Gilchrist contributed to this article.
