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Mini-budget: 'Trussonomics' baffles investors as bonds and pound tank

UK prime minister Liz Truss walks out of Number 10 Downing Street on her way to the House of Commons for the government's mini-budget. Photo: Daniel Leal/AFP via Getty
Liz Truss's economic vision for the future – dubbed 'Trussonomics' – has left some experts baffled. Photo: Daniel Leal/AFP via Getty

Kwasi Kwarteng unveiled his new fiscal plans in an emergency budget on Friday, announcing a range of tax-cutting measures to help jump-start the UK's ailing economy.

The chancellor hailed the "beginning of a new era" as he promised to deliver on prime minister Liz Truss's vision for economic growth — something analysts dubbed the "biggest tax-cutting event since 1972".

However, many financial experts and traders were left baffled as 'Trussonomics' sets its sail towards a 2.5% annual economic growth target.

Former US Treasury secretary Larry Summers told Bloomberg: "It makes me very sorry to say, but I think the UK is behaving a bit like an emerging market turning itself into a submerging market."

Read more: What is trickle down economics and how does it affect business and consumers?

It is not the first time that the PM's economic policy views have contrasted with leaders and drawn criticism.

Earlier this week she urged world leaders to follow Britain in introducing far-reaching tax cuts, setting her at odds with her US counterpart.

Truss is known to have supported the idea of "trickle-down economics" during the Conservative leadership race, arguing it was wrong to view all economic policy through the "lens of redistribution".

But on Tuesday, US president Joe Biden tweeted: "I am sick and tired of trickle-down economics. It has never worked. We’re building an economy from the bottom up and middle out."

The UK Treasury estimates that Friday's tax cuts will cost nearly £45bn a year in 2026, and the total package would be funded by increasing borrowing by £72.4bn.

To cover the costs, the measures would have to drive up gross domestic product (GDP) by 1% on current forecasts every year for five years, the Treasury estimated.

The Institute for Fiscal Studies argues that even though Truss and Kwarteng are believers in low taxation, their cuts would still leave taxation, as a share of GDP, at its highest sustained level since the 1950s.

The Resolution Foundation calculated that the worsening economic outlook since March and the extra energy support, are estimated to have increased borrowing by £265bn over the next five years.

Tax cuts of £146bn raise that to £411bn over the next five years, it said.

Markets across the board tumbled in response as investors digest the not-so mini "fiscal event" dominated by tax cuts funded through borrowing and deregulation.

The pound

Sterling (GBPUSD=X) plunged following the announcement, falling below the $1.10 threshold for the first time since 1985, edging nearing to the all-time low of $1,052.

The pound was already declining after another 0.75% interest rate hike from the Federal Reserve on Wednesday pushed the dollar to a fresh 20-year high.

But it lost further ground following the Bank of England's 0.5 percentage point rate lift and Kwarteng's fiscal announcement.

David Madden market analyst at Equiti Capital, said: "Currency traders are starting to question the UK’s ability to service its debt repayments, and that is being reflected in the rise in government bond yields - the higher borrowing cost indicates the perceived increased risk associated with lending money to the British government.

"Sterling is in the firing line as traders are turning their backs on all things British. There is a creeping feeling the extra government borrowing that is in the pipeline will severely weigh on the UK economy.

"GBP/USD has plummeted, largely down to the weakness in the pound, but by contrast, the US dollar is rallying on account of the flight to quality play."

Read more: Pound hits fresh 37-year low as Kwasi Kwarteng announces 'growth plan'

Bonds

Bond markets followed the pound's course after the Debt Management Office announced that they would be issuing £194bn in gilts this year — a rise of £62.4bn — to fund the additional spending.

That saw bonds suffer a record sell-off on the back of the news of this issuance with the yield on the five-year bond jumped as much as 57 basis points, surging above 4% — a record one day rise.

Gilt yields up and the pound down is a very worrying combination, as it is indicative of markets pricing in risk premia to the UK. "It's a clear sign that the UK's inflation fighting credibility is at stake," Mike Riddell at Allianz Global Investors said.

Watch: What is a recession and how do we spot one?