LONDON — New U.K. Prime Minister Liz Truss may have talked big on “trickle-down economics” during her campaign trail this summer, but no-one could have predicted the swathe of tax cuts unleashed just weeks into her Downing Street tenure.
Billed as a “mini-budget” by her Finance Minister Kwasi Kwarteng, Friday’s fiscal announcement was anything but with a volume of tax cuts not seen in Britain since 1972.
Truss — whose “Trussonomics” policy stance has been likened to that of her political idols Ronald Reagan and Margaret Thatcher — has now put the country on an economic road completely at odds with most, if not all, major global economies as inflation boils over and a cost-of-living crisis barrels into Europe.
It’s been seen, even by some of her advocates, as a political and economic gamble with Truss yet to face the wider British electorate in a nationwide 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 load to pay for the cuts — not typical of the low-tax Conservative governments of the past.
U.K. bond markets went into a tailspin Friday as investors shunned the country’s assets. Yields (which move inversely to prices) on the 5-year gilt rose by half a percentage point — which Reuters reported was the largest one-day rise since at least 1991.
And with bonds tanking, 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. On the week it lost 5% and is now down 27% since just before the 2016 Brexit vote.
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Wall Street banks are now seriously considering a break lower to parity with the U.S. dollar — for the first time in history — and many commentators have likened the pound to an emergency market currency.
Left-leaning The Guardian newspaper called it “a budget for the rich” on its front page Saturday, while The Times called it a “great tax 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 U.K.,” declining to comment on the currency moves.
ING analysts said in a research note that investors are worried that the U.K. Treasury has now effectively committed to open-ended borrowing for these tax cuts, and that the Bank of England will have to respond with more aggressive rate hikes.
“To us, the magnitude of the jump in gilt 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 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, especially if it wants to maximise its chances of fighting inflation with conventional tools like interest rate hikes. The QT [quantitative tightening] battle, in short, is not one worth fighting for the BOE,” they added, referencing the Bank’s move to normalize its balance sheet after years of stimulus.
ING also noted that the U.K.’s long-term sovereign outlook is currently stable with the big three ratings agencies, but the “risk of a possible shift to a negative outlook” could come when they are reviewed (Oct. 21 and Dec. 9).
Deutsche Bank analysts said, meanwhile, that the “price of easy fiscal policy was laid bare by the market” on Friday.
“[Friday’s] market moves suggest that there may be a credibility gap,” Sanjay Raja, a senior economist at Deutsche Bank, said in a research note.
“A plan to get the public finances on a sustainable footing will be necessary but not sufficient for markets to regain confidence in an economy sporting large twin deficits [the U.K.’s fiscal and current account balances],” he added.
“Crucially, with fiscal policy shifting into easier territory, the onus may now fall on the Bank of England to stabilise the economy, with the MPC [Monetary Policy Committee] having more work to do to plug the gap between expansionary fiscal policy and tightening monetary policy.”
—CNBC’s Karen Gilchrist contributed to this article.
