Written by Andy Bruce and Lindsey (NYSE: Dunsmuir)
LONDON (Reuters) – Britain’s New Economic Agenda represents the biggest gamble for growth in a major Western democracy in at least 40 years, as the chance of success immediately receded as investors dumped their sterling assets.
Prime Minister Liz Truss’s “growth plan” is Britain’s second roll of the dice in economic renewal after the 2016 vote on Brexit, which, so far at least, has failed to generate returns.
Investors responded with alarm at the combination of free spending, unfunded tax cuts and huge increases in government borrowing announced by Finance Minister Kwasi Kwarting on Friday.
His statement marked a step change in British economic policy, returning to the 1980s Thatcher and Reaganomics doctrines which critics derided as a return to the “going down” theory.
The British pound fell below $1.09 for the first time since 1985 and British government bonds suffered their biggest daily drop in decades.
International observers looked baffled, even if home business groups saw an advantage in many of the plans outlined by Kwarteng, who says low growth is the real gamble.
“I have rarely seen economic policy pursued uniformly by economists and financial markets,” said Harvard professor Jason Furman, former chair of the American Council of Economic Advisers during Barack Obama’s presidency.
“It was shockingly less than the low expectations that almost everyone had,” he added.
Willem Potter, a former interest-setting officer at the Bank of England and Citi’s chief global economist until 2018, said Kwarteng’s plans to ramp up borrowing were “absolutely insane”.
“From a cyclical perspective, I think it’s a disaster,” Bueter said, adding that he had no objection in principle to tax cuts for businesses and households with better fiscal balance.
“This is potentially an example of casino macroeconomics,” said Jacob Kierkegaard, a non-resident senior fellow at the Washington-based Peterson Institute for International Economics.
In Germany, director of the German Council on Foreign Relations (DGAP) Guntram Wolff said Truss’ plans amounted to a “Singapore on the Thames” attempt to liberalize the British economy and boost the City of London.
“The economy has more than Citi … It is not surprising that the pound lost today,” he said.
Slowly, all at once
Kwarteng said on Thursday that his plans to grow the economy would “build a stronger capacity to relieve inflationary pressure”.
On Friday, those plans sparked a market crash that would only exacerbate inflation in the months, and possibly years, to come — automatically raising the bar for the ultimate success of Kwarteng’s plan.
US investment bank Citi said the pound risks a crisis of confidence among international investors.
“The danger now is that the UK government has discredited it in one fell swoop, and you saw that with the waves of market runoff,” said Dan Hamilton, a non-resident senior fellow at the Brookings Institution, a US think-tank.
The collapse in investor sentiment leaves a serious problem for Bank of England Governor Andrew Bailey.
“Fiscal and monetary policy are now at war with each other in the UK,” Foreman said.
Hamilton agreed, adding that this tension was not evident in other major economies.
In the financial markets, few analysts are predicting that the Bank of England will have to raise interest rates before its next rate meeting.
“I think if you were Andrew Bailey and you were just looking at the details of market moves, you would have already called an emergency meeting,” Kierkegaard said.
Buiter said he could think of few historical parallels to Britain’s new fiscal approach, even if there are superficial parallels to the Thatcher tax-cut years.
The British Institute for Fiscal Studies compared Kwarteng’s statement to the 1972 budget which similarly sought to double Britain’s economic growth rate, but is widely cited as a disaster for its inflationary effect.
Foreman doubted that Truss would be able to carry out her plans before falling into some hard economic realities, as happened to Ronald Reagan in the early 1980s.
The US Republican president was forced back into a major tax cut campaign as the US Federal Reserve raised interest rates.
Foreman said Truss may have no other choice but to back down from some of her plans if Britain’s debt problems start to escalate due to higher interest rates.
“Sometimes the hand of the state is forced,” he said.
(1 dollar = 0.9111 pounds)