Image source: Axios
Liz Truss’s tenure as the British PM began with global markets sinking at her approach to rekindling the trickle-down economics of the 1980s. The plan was abandoned shortly thereafter, but the damage to her cabinet’s credibility was already done.
By Tomasz Jankowski
Liz Truss’s tenure as prime minister of the United Kingdom began tumultuously with the death of Queen Elizabeth II. Not long thereafter, the new Chancellor of the Exchequer, Kwasi Kwarteng, announced the biggest tax cuts Britain has seen since the 1970s. The cuts are estimated to be worth £45bn and are to be entirely debt-funded with the intention of stimulating the supply side of the economy. This comes after the UK’s recent announcement of borrowing schemes intended to cover the rising costs of energy. Following Kwarteng’s announcement, the Debt Management Office of the UK announced that its financing needs for 2022-2023 have risen to a total of £234bn. The Institute for Fiscal Studies, a UK-based think tank, estimates that even after the energy subsidy scheme expires, public debt would amount to £110bn in 2027; economists from Citi, however, produced a much higher estimate of £150bn by 2026.
In response to the Chancellor’s announcement, global stocks and bonds, as well as the British pound, fell sharply to its lowest-ever level against the US Dollar. Yields on the 10-year gilt spiked to their highest level since 2008 as yields move inversely to prices, and the FTSE 100 dropped by nearly 6% in a matter of days. The UK mortgage market was not immune either as Santander and HSBC, two of the UK’s largest mortgage lenders, suspended new loans, leaving home buyers unable to secure financing in the wake of rising rates. The effects similarly rippled through global markets, with the Dow Jones, EURO STOXX 50, and Nikkei all dropping on Kwarteng’s announcement.
The backlash from the global financial community in response to the tax cuts was substantial, and in some instances, unprecedented. Larry Summers, the former US Treasury Secretary, compared the activity of the British government to “a bit like an emerging market turning itself into a submerging market.” The IMF Chief Economist Olivier Blanchard labeled the move as a “textbook example of how not to design and not to sell a fiscal expansion.” Boston and Atlanta Fed officials contended that the shock created by the tax cuts could send the US into a recession, as uncertainty often drives away consumers and businesses from participating in the market.
Some days after the announcement, the Bank of England launched a series of programs to mitigate the devastating blow the tax cut announcement inflicted. The BoE launched a £65bn bond-buying program in an effort to alleviate some of the pressure on markets while also suspending the sale of gilts in an effort to tame inflation. The move came after the BoE refused to hold an emergency session to raise rates before its regularly-scheduled November meeting. While the bond-buying led to a rally in international government debt, some economists criticized the program as adding fuel to the inflationary fire. Handelsbanken’s UK Chief Economist argued that “this move will be inflationary at a time of already high inflation” given that the Bank is injecting billions into the economy via its bond-buying.
A week after the cut, the pound managed to recoup its losses from the past week after Truss met with the Office for Budget Responsibility. These small gains were not enough to fully mitigate the damage done, however; the pound remains approximately 16% lower year-to-date against the dollar at the time of writing. All told, the tax cuts, which seem to many as a veiled approach to rekindling the trickle-down economics of the 1980s, sent the UK economy, which was already experiencing substantial inflationary pressure and dwindling consumer confidence, into a panic.
Then, in an unexpected turnaround, on October 3rd, Kwarteng announced that the 45% tax cut plan will not go forward. The decision came after it became clear that the cuts would not make it through the House of Commons after Tory MPs refused to back the plan. Kwarteng’s new medium-term fiscal plan aimed to reduce government debt in the next five years. This was to be achieved, among other measures, through a tightening of government spending. Truss, increasingly resembling a modern Thacherthite, maintains that this is not a form of austerity.
The reversal of the mini budget temporarily restored faith in the sterling, only for investors to lose confidence in the currency shortly thereafter. After hitting an all-time low of $1.07, the sterling rebounded to pre-tax cut announcement levels of $1.15, only to slump to $1.11. On the other hand, currently trading at its lowest level since the start of the pandemic lockdowns, the FTSE has yet to experience even a slight increase in investor confidence. The yield on the 10-year gilt is the highest level since 2008 — 4.45%.
10-year Gilt Yield YTD
FTSE 100 (UKX) YTD
The substantial declines in several key British asset classes illustrate investors’ lack of faith in Truss and Kwarteng’s ability to bring the UK out of a state that is teetering on the edge of a full-blown crisis. Despite rolling back the original tax cuts, the damage to the Exchequer and PM’s credibility was already done as they not only illustrated poor fiscal planning, but also a lack of follow-through and authority.
On October 14th, after a barrage of criticism, Truss dismissed Kwarteng as Chancellor after it became clear that the markets have lost faith in his ability to reduce inflation in Britain. Jeremy Hunt succeeds Kwarteng as Truss seeks to regain credibility and completely divert away from the plans she devised with the former Chancellor. Hunt has bought the PM some breathing room by scrapping the previous growth strategy almost entirely. Most notably, Hunt will not decrease the corporate tax rate which will save the Treasury some £32bn (instead of costing it £45bn). The markets seem to place more faith in Hunt’s leadership to a certain extent as he is embracing more traditional inflation-reducing measures rather than promoting growth at a time when prices need to fall. However, gilt yields continue to remain higher than they were prior to Kwarteng’s mini budget being announced, illustrating that Truss is still far from regaining the trust of investors.
Truss and Kwarteng’s plans to revitalize the British economy with Thatcher-esque tax cuts have been met with intense backlash from investors, members of both the Tory and Labour parties, and a host of international economic agencies alike. Sacking Kwarteng and appointing Hunt may be a step in the right direction. However, Truss continues to face an extremely steep hill. Another misstep may not only result in more turnover on Downing Street, but also in a domestic crisis that may rattle economies all over the globe and be the trigger that kick-starts a global recession. □
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