The crisis of confidence had been brewing for years. Dubious claims from the ruling Conservatives — ranging from Brexit’s benefits to parties in Downing Street during lockdown — together with the recent ousting of the Treasury’s top official and the side-lining of the country’s budget watchdog meant investors didn’t believe the Chancellor when he promised to stabilize the public finances.
The markets “aren’t willing to trust the Truss administration’s claims that it will deliver medium-term fiscal sustainability on the basis of its word alone,” said Allan Monks, an economist at JPMorgan Chase & Co. in London. “That reflects a broader distrust in markets about how UK policy making has been evolving — and in our view, that distrust is entirely justified.”
Nothing illustrates it better than the slide in the pound. It’s fallen from a high of more than $2 in 2007, just before the financial crisis, to $1.50 at the time of the Brexit referendum, and is now on the brink of parity with the dollar.
“Because the UK has damaged its once strong credibility with a poorly managed Brexit and persistent threats of a UK-EU trade war, it no longer enjoys the benefit of the doubt,” said Berenberg’s Pickering.
For JPMorgan’s Monks, the doubts set in before the 2016 Brexit referendum, accelerated after the shock result, and culminated in recent attacks on the central bank, the judiciary, and the civil service.
Nevertheless, Friday’s act of fiscal largess — being unfunded — marked a major break from the economic traditions of Truss’s Conservative Party. The government still needs to set out how it will cover the additional borrowing required to fund its £45 billion of tax cuts and further £60 billion-plus for its program to offset the recent surge in energy bills.
Those measures will drive up the country’s budget deficit to 4.5% of gross domestic product. That would be enough to put the debt burden on an explosive path, hitting 101% of GDP by 2030, according to Bloomberg Economics.
In the meantime, the Bank of England will come under mounting pressure. The central bank has spent much of the year struggling to raise interest rates fast enough to combat a surge in inflation it failed to predict.
The BOE is now all but guaranteed to respond to the looser fiscal policy with tighter monetary policy. Money market traders are now betting on at least a 150 basis-point rise in interest rates by policymakers' next gathering on Nov. 3. Setting aside the risk of an emergency hike outside of scheduled meetings, that would be a move unprecedented since the bank was granted independence by the government in 1997. Pricing also shows the benchmark rate will almost certainly hit 6% next year.
