LONDON (CN) — The United Kingdom's government is facing a major crisis of confidence amid market turmoil in response to the new economic approach set out by Prime Minister Liz Truss and Chancellor Kwasi Kwarteng.
A "mini budget" released by Kwarteng last week promised to fund 45 billion pounds ($50 billion) worth of tax cuts through borrowing. The announcement immediately triggered a financial crisis that has sent the pound tumbling on foreign exchange markets to some of its lowest levels in history and left the government at loggerheads with the U.K.’s central bank over economic policy, in an extraordinary week in British politics.
Markets are spooked by the new economic direction the U.K. is taking under Truss, who is less than a month into the job. In particular, the massive expansion of borrowing announced by the new government is viewed by lenders as excessively risky and has undermined the U.K.’s reputation for fiscal prudence.
The growing expectation of large interest rates in response to the falling pound poses a danger to the U.K.’s housing market. Highly inflated house prices across the economy mean that many homeowners will be unable to keep up with their mortgage payments in a high-interest environment, risking mass foreclosures.
At the same time, the loss of confidence in the government’s borrowing plans poses a severe risk to pension funds, which are heavily invested in U.K. government bonds.
The sudden uncertainty surrounding mortgages and pensions are hugely disruptive for the Conservative Party’s electoral appeal. The governing party’s primary constituencies among the British public are homeowners and pensioners. By increasing anxiety among these groups, the government is undermining its own electoral base.
And indeed the response from the public has been swift. Polling released by YouGov on Thursday evening put the opposition Labour Party a massive 33-points ahead of the Conservatives – 54% compared to 21%. The last time Labour recorded such a giant lead in the polls was in 1996, just prior to Tony Blair’s historic landslide general election victory.
In that election, Labour ultimately secured a 13-point lead over the Tories. If the polling result from Thursday evening was repeated in a general election, it would spell electoral oblivion for the Conservative Party – a result without precedent in British politics.
The crisis began last Friday, when Kwarteng delivered a so-called “mini budget” to Parliament. In the budget he announced a number of tax reductions, including the scrapping of the top rate of income tax, and the cancellation of a planned rise in corporation tax. The measures are primarily of benefit to high earners, and reflect Truss and Kwarteng’s well-known belief that reducing the tax burden on the wealthy will spur economic growth.
The decision to propose a mini budget, rather than a formal budget, had already sparked controversy. It meant the financial plans could avoid scrutiny from the Office of Budget Responsibility, or OBR. The independent OBR is responsible for formal analysis of government fiscal policy, and for outlining its likely effects on the economy.
Kwarteng had claimed that the OBR would not be able to produce a report on his plans in time. However, the OBR disputes this, saying it would be able to do so and had offered as much to the chancellor.
The uncertainty over the cost of tax cuts, along with the lack of formal government analysis of its impact, sent financial markets into a tailspin almost immediately. Before the chancellor had even concluded his speech, a mass sell-off of government bonds had begun, with widespread skepticism among traders of the sustainability of the mass-borrowing plans being announced.