Plunging Pound And Crumbling Confidence: How The New UK Gove...| MENAFN.COM

Saturday, 10 December 2022 01:47 GMT

Plunging Pound And Crumbling Confidence: How The New UK Government Stumbled Into A Political And Financial Crisis Of Its Own Making


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(MENAFN- The Conversation)

The new British government is off to a very rocky start – after stumbling through an economic and financial crisis of its own making.

Just a few weeks into its term on Sept. 23, 2022, Prime Minister Liz Truss' government released a so-called mini-budget that – about US$184 billion at today's rate – in new spending and the , with the benefits . The aim was to jump-start growth in an economy on the , but the government didn't indicate how it would pay for it – or provide evidence that the spending and tax cuts would actually work.

Financial markets reacted badly, prompting and the pound to plunge to the lowest level against the dollar since 1985. The Bank of England to avoid a financial crisis.

After days of defending the plan, the government of sorts on Oct. 3 by scrapping the most controversial component of the budget – elimination of its top 45% tax rate on high earners. This calmed markets, leading to a rally in the pound and government bonds.

As a who tracks markets closely, I believe at the heart of this mini-crisis over the mini-budget was a lack of confidence – and now a lack of credibility.

A looming recession

Truss' government .

Growth has been sluggish, with the latest quarterly figure at 0.2%. The the U.K. will soon enter a recession that could last until 2024. The latest data on U.K. manufacturing shows .

Consumer confidence is at its lowest level ever as soaring inflation – – drives up the cost of living, especially for food and fuel. At the same time, real, inflation-adjusted , or around 3%.

It's important to note that many countries in the world, including the U.S. and in mainland Europe, are experiencing the same problems of low growth and high inflation. But rumblings in the background in the U.K. are also other weaknesses.

Since the financial crisis of 2008, the U.K. compared with other major economies. Business investment plateaued after Brexit in 2016 – when a the European Union – and remains significantly below pre-COVID-19 levels. And the U.K. also consistently runs a , which means the country imports a lot more goods and services than it exports, with a trade deficit of over 5% of gross domestic product.

In other words, investors were already predisposed to view the long-term trajectory of the U.K. economy and the British pound in a negative light.

An ambitious agenda

Truss, who became prime minister on Sept. 6, 2022, also didn't have a strong start politically.

The government of Boris Johnson lost the confidence of his party and the electorate after a series of scandals, including and revelations about while the country was in lockdown.

Truss was of lawmakers in her own Conservative Party, who had the task of submitting two choices for the wider party membership to vote on. The rest of the party – dues-paying members of the general public – chose Truss. The lack of support from Conservative members of Parliament meant she wasn't in a position of strength coming into the job.

Nonetheless, the new cabinet of cutting taxes and deregulating energy and business.

Some of the decisions, , were expected, such as subsidies limiting higher energy prices, reversing an increase in social security taxes and a planned increase in the corporate tax rate.

But others, notably a plan to abolish the 45% tax rate on incomes over £150,000, were not anticipated by markets. Since there were no explicit spending cuts cited, funding for the £161 billion package was expected to come from selling more debt. that this would be paid for, in part, by lower welfare payments at a time when poorer Britons are suffering from the soaring cost of living. The fear of welfare cuts is on the Truss government.


The cost of living crisis in the U.K. has everyone looking for deals where they can. A collapse in confidence

Even as the new U.K. Chancellor of the Exchequer Kwasi Kwarteng was presenting the mini-budget on Sept. 23, the British pound was already getting hammered. It sank from $1.13 the day before the proposal to . Yields on 10-year government bonds, known as gilts, – the highest level since 2008 – in the same period.

The jump in rates with new customers, eventually offering them again at significantly higher borrowing costs. in the housing market.

In addition, the drop in gilt prices , putting them at risk of insolvency.

Many members of Truss' party to the high levels of borrowing likely necessary to finance the tax cuts and spending and .

The International Monetary Fund, which , even on the tax cuts, urging the government to“” the plan. The comments .

To prevent a broader crisis in financial markets, the Bank of England in government bonds.

Besides causing investors to lose faith, the crisis also severely dented the public's confidence in the U.K. government. The latest polls showed the opposition Labour Party , on average, over the Conservatives.

So the government likely had little choice but to of the plan, the abolition of the 45% tax rate. The pound recovered its losses. The recovery in gilts was more modest, with bonds still trading at elevated levels.

Putting this all together, less than a month into the job, Truss has lost confidence – and credibility – with international investors, voters and her own party. And all this over a“mini-budget” – the full budget isn't due until November 2022. It suggests the U.K.'s troubles are far from over, a .


The Conversation

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