(Bloomberg) — Liz Truss’s growth plan, which combines the biggest tax break in half a century with the liberalization of Thatcher, is a direct gamble with Britain’s future, even before the Treasury finishes delivering it on Friday. I started sour.
The market’s verdict on Kwasi Quarting’s £220 billion blitzkrieg campaign was swift and devastating. Sterling fell below $1.11 for the first time since 1985, bringing its decline for the year so far to 19%. Five-year Treasuries posted their biggest daily drop ever.
“The markets will do whatever they want,” said Quarting, 47, when he was challenged in the House of Commons over the chaos he had unleashed.
Even before the chancellor’s statement, former Bank of England policymakers had been warning that Prime Minister Liz Truss’s determination to cut taxes no matter the circumstances was threatening to push the UK into a sterling crisis.
There was still a sense of shock about how far her advisor had gone, scrapping the highest income tax rate in boost for higher-income earners, as well as cutbacks for corporate tax, National Insurance contributions and fees on home purchases that had been previously reported.
The final total didn’t even include the full cost of paying home energy bills for the next two years. That could add another £100 billion to taxpayers’ liabilities.
The tax cuts will cost the Treasury around £161 billion over the next five years. An additional energy guarantee will add about £60 billion to that amount in the next six months, the only figure given by the Treasury.
Those staggering numbers have led analysts to reach into the history books to compare the package to famous policy mistakes in the past. The reaction – with the pound declining even as traders price sharp increases in interest rates to offset the increase in inflationary pressures – is the type of movement usually restricted to emerging market currencies.
“Investor confidence is eroding rapidly,” said George Saravelos, global head of foreign exchange research at German Bank (ETR :). He called for an emergency rate hike from the Bank of England.
The reaction leaves Truss and Quarting in a terrible predicament. Truss, also 47, took office less than three weeks ago. Her efforts to impose her power over the government were halted by the death of Queen Elizabeth II, bringing politics to a halt for 10 days. Truss has a dire need to show she can steer the UK through the global energy crisis.
She was elected Leader of the Conservative Party during the summer due to her popularity with membership. But two-thirds of her deputies voted against her, and there were mutterings about a possible vote of no-confidence before she took office.
The fear among investors is that Truss’s tax cuts will give the economy nothing more than a sugar rush, spurring debt and spiraling inflation, before a crash that leaves no lasting improvement in long-term growth.
Even government fans were lukewarm in their support. “They are trying the right things, but there has to be a risk that we are going into a haircut boom, by pushing the inflation button,” said Crispin Ody, a Conservative supporter and founder of the hedge fund Odey Asset Management where Kwarteng once worked as an analyst.
This is a reference to the ill-fated 1972 budget set by Quarting’s predecessor, Anthony Barber. Barber, like Kwarteng, introduced a massive package of unfunded tax cuts, which, in his case, saw the economy skyrocket and inflation soar before collapsing into recession. Barber’s boss, Edward Heath, was defeated by Labor opposition two years later, and the UK had to seek an IMF bailout in 1976.
What Bloomberg Says About Economics…
“The policies announced in Chancellor Kwasi Quarting’s mini-budget will provide the economy with a sugar rush over the next year, but we highly doubt they will turn around the growth on which the government depends. This means that it will raise inflation at a time when the Bank of England is trying to cool price pressures, and because the policy package Unfunded, the debt puts the debt on an unsustainable path.”
– Dan Hanson, Bloomberg Economics. Click for insight.
Likewise, Truss may have less than two years before she also has to call an election.
Truss has been clear that what she cares about is maximizing the economic pie, rather than worrying about how to divide it.
This audacity is most evident in the central gamble at the heart of the mini-budget. Success hinges on a single number: Kwarteng’s growth target of 2.5%, which is nearly a full percentage point higher than official forecasts for the next three years and a level last seen before the 2008 financial crisis.
If the government can raise GDP growth by a percentage point, the tax cuts will pay for themselves by the end of five years, according to Treasury documents published Friday. At this point, the government will have stabilized the national debt, fixed the UK’s productivity dilemma, and given the country the competitive advantage of lower taxes.
Martin Weil, a former interest rate setter at the Bank of England now at King’s College London, described the growth target as “pie in the sky”. He said the government can’t be sure it will get 2.5% growth, but it can make sure the tax cuts put public finances in a precarious position.
Resolution has forecast that government borrowing as a share of GDP will rise over the net five years, adding a total of £411 billion to the current debt pile of £2.3 trillion.
At the same time, the benefits of the tax cuts are skewed towards higher-income earners – who are more likely to vote for the Conservative Party. A person earning £200,000 would be better off £5,220 as a result of the tax cuts, while a worker earning £20,000 would only earn £157.
“After 12 years running the country, conservatives desperately need to establish a fast-delivery track record if they are to cling to power,” said Ryan Shorthus, chief executive of think-tank Bright Blue. “The prime minister and chancellor will fail.”
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