Over the past month, the pound has declined significantly against both the euro and a trade-weighted basket of currencies. By making imports more expensive, this will contribute to inflation just when other inflationary pressures may be easing.
Still, it would be wrong to speak of a “sterling crisis” – or at least not yet. The term “currency crisis” is generally associated with fixed exchange rate systems where a currency is eventually forced by the markets to devalue. Since exiting the European Exchange Rate Mechanism, the pound has floated, bouncing up and down depending on sentiment. So there can be no crisis in the previous sense of the term.
But defeat could still happen, and that’s the worry, as the government ramps up public spending again – this time to deal with the energy crisis – while embarking on potentially very significant, unfunded tax cuts. The markets are not yet convinced of Trussonomics; with some trepidation they await the news of exactly what that means in Friday’s “tax return”.
The overall low taxes and the new British government’s small-state aspirations would normally be well received by the financial markets. The problem is that we’ve heard quite a bit about the former but very little about the latter; A high-spending, low-tax economy is a contradiction in terms, the prospect of which is making markets extremely uneasy.
A looming recession, dangerously high reliance on foreign capital inflows, widening current account and budget deficits, high inflation, soaring interest rates, a growing structural deficit in the primary income account—it all adds up to a rather toxic cocktail.
It’s easy to see why markets are concerned, and that’s before you add any lingering doubts about Brexit and a government that doesn’t appear to care the slightest about fiscal discipline or even the independence of the Bank of England.
It is imperative that some of these fears are defused in Friday’s statement. Markets need some sense of reassurance. The Bank of England may have failed miserably in its core task of maintaining price stability over the past year, but this is not the moment to change the mandate and undermine monetary independence. Government also needs credible fiscal rules, restrictive as they may be.
Trussonomics deserves a fair hearing. After years of campaigning for a lower-tax economy, it would be ill suited to me to criticize such an effort now that we have a government that is obviously serious about implementation. Other aspects of the new government’s supply-side, growth-oriented economic agenda also have strong appeal.
But even that looks suspiciously like a government that believes it has nothing to lose and is therefore willing to take big risks if it goes bust; It either works or it’s left to the opposition to clean up the resulting chaos on the other side of the next election.
And I wonder if ministers have fully thought through the political implications of the growth agenda they are proposing. For example, the most obvious way to improve productive potential is to dismantle planning and immigration controls. Some have tried; politically, few survived to tell the story. Truss isn’t just dealing with Treasury and Bank of England orthodoxy; it’s also a strong spectrum of self-interest, quite a lot of it within her own party.
The currency markets can hardly be accused of skepticism. The ever-sinking pound tells you they don’t see the chances of the new prime minister. But let’s hear what your Chancellor, Kwasi Kwarteng, has to say before you pass judgement.
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