Financial markets tell Truss she’s not trusted

On Friday, Britain’s government announced a shift in fiscal policy aimed, it said, at stimulating growth and investment. If the new prime minister, Liz Truss, was expecting financial markets to applaud this bold initiative, she’ll have been disappointed. Investors handed her a stunning rebuke. Interest rates soared and sterling slumped to a 37-year low — a combination expressing zero confidence in the program she and her finance minister laid out.
Following this worst possible start to her premiership, Truss needs to understand what went wrong and take prompt corrective action. Note that the problem isn’t confined to the content of Friday’s “mini-budget,” bad as that was. As a minister and during her campaign to succeed Boris Johnson as prime minister, Truss had already built a reputation for recklessness. The new fiscal policy seemed to affirm it. She must put this right in short order, or things will go from bad to worse.
The new fiscal plan includes tax cuts worth some 45 billion pounds over the next five years — Britain’s biggest such package since the 1970s. It trims the basic rate of income tax by a percentage point and the rate applied to high incomes from 45% to 40%. It cuts the tax on property sales and provides generous new incentives for investment. These cuts will be introduced alongside a huge expansion of public spending on energy subsidies, intended to soften the blow of high inflation. Together these changes are likely to increase public borrowing by some 5% of gross domestic product.
The plan is badly designed. It’s regressive at a time when the financial pressure on low-income households is acute. It cushions the effect of extremely high gas prices by lowering energy prices for everybody (which is partly self-defeating, because it will boost demand), rather than by helping those most in need. Strong budget stimulus delivered just as the Bank of England is raising interest rates to reduce demand sets monetary and fiscal policy at odds, meaning the central bank will have to raise rates by more than would otherwise have been necessary. That will put financial markets under added stress, and make the new borrowing more expensive.
Flawed as the plan might be, its intentions are not indefensible. In theory, a big fiscal expansion will soften the sharp recession that was in prospect. Truss is right about the need for higher investment. Yes, the extra borrowing will delay the reduction of public debt — but, all being well, not dangerously. The UK’s public debt will still be lower in relation to output than in the US and much of Europe.
For all these reasons, investors might have given a government they trusted the benefit of the doubt. Unfortunately, at every turn, Truss has worked to undermine their confidence.
During her campaign for the leadership, she mooted the possibility of changing the Bank of England’s long-established price-stability mandate — a half-baked proposal that threatened to de-anchor inflation expectations. Her position on the vital matter of Brexit and relations with the European Union was equally unsettling. Far from doing everything possible to repair relations, she threatens to dictate terms to the EU on resolving a dispute over trade between Northern Ireland and the rest of the UK. Reckoning that Britain has less to lose than the EU if trade between the two breaks down is brave. It’s also idiotic. Why the meltdown on Friday? Because Truss’s new fiscal policy fits this pattern all too well. No more timidity. We will boost spending and cut taxes, and never mind the consequences.
—Bloomberg