Britain’s Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng visit Berkeley Modular in Northfleet, Kent, Britain September 23, 2022. REUTERS/Dylan Martinez/Pool
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LONDON, September 24 (Reuters) – Britain’s new economic agenda represents the biggest gamble for growth in a major Western democracy in at least 40 years, for which the odds of success immediately plummeted as investors dumped sterling assets.
Prime Minister Liz Truss’ “growth plan” is Britain’s second roll of the dice in economic renewal after the 2016 Brexit vote, which has yielded no returns, at least so far.
Investors reacted with dismay to the combination of free spending, unfunded tax cuts and huge increases in government borrowing announced by Finance Minister Kwasi Kwarteng on Friday. Continue reading
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His statement marked a crucial shift in British economic policy, and tied in with the doctrines of the Thatcher and Reaganomists of the 1980s, derided by critics as a return to trickle-down theory.
The pound plunged below $1.09 for the first time since 1985 and UK government bonds suffered their biggest daily decline in decades. Continue reading
International observers watched in bewilderment, though domestic business groups made good sense of many of the plans outlined by Kwarteng, who says slow growth is the real gamble.
“I have seldom seen economic policy planned so coherently by economists and financial markets,” said Harvard professor Jason Furman, former chairman of the US Council of Economic Advisors during the Obama presidency.
“Amazingly, it was below the low expectations that almost everyone had,” he added.
Willem Buiter, a former Bank of England rate setter and chief economist at Citi until 2018, said Kwarteng’s plans to increase borrowing are “really, unreally crazy”.
“From an economic point of view, I think this is a disaster,” Buiter said, adding that he has nothing against tax cuts for companies and households with better budget balances in principle.
“It’s probably the epitome of casino macroeconomics,” said Jacob Kirkegaard, nonresident senior fellow at the Washington-based think tank Peterson Institute for International Economics.
In Germany, Guntram Wolff, director of the German Council on Foreign Relations (DGAP), said Truss’ plans amounted to a “Singapore-on-Thames” attempt to deregulate Britain’s economy and boost the City of London.
“The economy has more than the city… It’s no surprise that the pound sterling is down today,” he said.
SLOWLY, THEN AT ONCE
On Thursday, Kwarteng said his plans to grow the economy would “build stronger capacity to ease inflationary pressures.”
On Friday, those plans triggered a market meltdown that will exacerbate inflation in the months and possibly years to come – automatically raising the bar on the eventual success of Kwarteng’s plan.
US investment bank Citi said sterling risked a crisis of confidence among international investors.
“The risk now is that the UK government has reduced its credibility in one fell swoop, and you saw that with the market outflows,” said Dan Hamilton, senior fellow at the Brookings Institution, a US think tank.
The slump in investor sentiment poses a serious problem for Bank of England Governor Andrew Bailey.
“Fiscal and monetary policy are now at war in the UK,” Furman said.
Hamilton agreed, adding that this tension is not evident in other major economies.
In financial markets, some analysts are predicting that the BoE will be forced to hike rates ahead of its next rate meeting.
“I think if you were Andrew Bailey and just looking at the details of market action, you would have already called an emergency meeting,” Kirkegaard said.
HISTORY CLASS
Buiter said he could think of few historical parallels for Britain’s new fiscal approach, even if there were superficial similarities with Thatcher’s tax-cut years.
Britain’s Institute for Fiscal Studies compared Kwarteng’s statement to a 1972 budget that similarly aimed to double Britain’s economic growth but is widely remembered as a disaster for its inflationary impact.
Furman doubted Truss would be able to carry out her plans before hitting some hard economic truths, as happened to Ronald Reagan in the early 1980s.
The Republican US President was forced to reverse a major tax cut initiative as the US Federal Reserve hiked interest rates.
Furman said Truss may also have no choice but to roll back some of their plans if Britain’s debt problems start to worsen due to higher interest rates.
“Sometimes a country is forced,” he said.
($1 = 0.9111 pounds)
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reporting by Andy Bruce; Editing by Jonathan Oatis
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