Financial Markets Tell Truss She’s Not Trusted

On Friday, the UK government announced a change in fiscal policy aimed at boosting growth and investment. If new Prime Minister Liz Truss expected financial markets to applaud this bold initiative, she was disappointed. Investors gave her a startling rebuke. Interest rates have soared and sterling has fallen to a 37-year low – a combination that shows zero confidence in the program she and her finance minister are drafting.

After the worst possible start to her premiership, Truss needs to understand what went wrong and take immediate corrective action. Note that the problem isn’t limited to the content of Friday’s “mini-budget,” bad as that was. As a minister and during her campaign to succeed Boris Johnson as prime minister, Truss had already acquired a reputation for recklessness. The new fiscal policy seemed to confirm this. She needs to fix this in a short amount of time or things will only get worse.

The new fiscal plan envisages around £45 billion worth of tax cuts over the next five years – Britain’s largest such package since the 1970s. It cuts the basic income tax rate by one percentage point and the high-income tax rate from 45% to 40%. It lowers the property sales tax and provides generous new investment incentives. These cuts are being introduced along with a huge increase in public spending on energy subsidies to soften the blow of high inflation. Together, these changes are expected to increase public borrowing by about 5% of gross domestic product.

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The plan is poorly designed. It’s declining at a time when financial pressures on low-income households are acute. It cushions the impact of extremely high gas prices by lowering energy prices for everyone (which is partially self-defeating because it will boost demand) rather than helping those most in need. Strong fiscal stimulus, delivered just as the Bank of England is raising interest rates to curb demand, brings monetary and fiscal policy into conflict, meaning the central bank must hike rates more than this otherwise would have been required. This will put additional pressure on the financial markets and make new borrowing more expensive.

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However flawed the plan, its intentions are not untenable. In theory, strong fiscal expansion will moderate the expected sharp recession. Truss is right about the need for more investment. Yes, the extra borrowing will delay deleveraging – but if all goes well, not dangerous. The UK’s public debt relative to production will still be lower than in the US and much of Europe.

For all of these reasons, investors would have agreed with a government they trusted when in doubt. Unfortunately, Truss worked at every turn to erode their trust.

During her campaign for leadership, she considered the possibility of changing the Bank of England’s long-established price stability mandate – a half-baked proposal that threatened to unanchor inflation expectations. Equally troubling was her stance on the vital issue of Brexit and relations with the European Union. Far from doing everything to restore ties, she is threatening to dictate terms to the EU to settle a dispute over trade between Northern Ireland and the rest of the UK. To reckon the UK has less to lose than the EU if trade between the two collapses is bold. It’s also idiotic.

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Why the meltdown on Friday? Because Truss’ new fiscal policy fits this pattern all too well. No more shyness. We will increase spending and lower taxes, regardless of the consequences.

Truss obviously aspires to be a pro-market revolutionary in the mold of Margaret Thatcher. Boldness is good, to be sure. But investors (and, in due course, voters) also demand wisdom and competence. If it’s not already too late, Truss must summon some.

More from the Bloomberg Opinion:

• Market meltdown sends UK government warning: Mark Gilbert

• Give bankers bigger bonuses? Great Britain playing with fire: Marcus Ashworth

• Britain takes wrong approach to saving energy: Javier Blas

The editors are members of the Editorial Board of Bloomberg Opinion.

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