On September 23rd, 2022, the British Government under then Prime Minister Liz Truss announced a new government financial package, the so-called mini-budget. A combination tax plan and stimulus program which would see the British Government slash taxes on income and corporate profit while, at the same time, spending billions of pounds in stimulus. The mini-budget was intended to reinvigorate the British economy and deal with the cost of living crisis. The plan was more drastic than economists and analysts had anticipated, resulting in a loss of confidence and causing the pound to plunge to its lowest point against the dollar since 1985. By September 26th, the pound was trading at a value of $1.04, only $0.01 lower than the previous lowest point ever in 1985.
This plunge can be described as a fundamental loss of market confidence in the British Government. The mini-budget plan had called for deficit spending to protect consumers and boost growth while cutting the tax burden to encourage business investment. However, many considered this unwise as it would raise the pressure on inflation, which according to the Bank of England, is roughly around 9%. Increase the national debt. The plan was also seen as likely to only exacerbate the cost of living crisis and possibly lead to the very thing it sought to avoid, a recession.
Prior examples of British unfunded tax cuts in the vein of the mini-budget were in 1972 and the late 1980s. They resulted in rapid inflation, market overheating, and then the collapse into recession. The 1972 tax cuts created a fiscal situation where Britain defaulted on its debt and required an International Monetary Fund (IMF) bailout to remain solvent. In the late 1980s and early 1990s, it led to a recession. Based on these past examples, and with a world market already roiling from energy cost spikes due to the war in Ukraine, inflation, and the fight in many countries to curb it. The mini-budget was the last straw causing the market to downgrade the U.K.’s creditworthiness, increasing borrowing costs for the U.K. In turn, causing investors to flee the pound towards the global world’s reserve currency, the U.S. dollar. The effect was not helped by the fact that the U.S. dollar had been slightly strengthening against the British Pound and the Euro since the war in Ukraine.
This yo-yo effect on the value of the British pound came as just another hit to the already fragile British economy. The country is still sluggishly recovering from the enforced pandemic shutdowns, energy shocks, and the death of Queen Elizabeth. Britain is facing a severe cost of living crisis, with many people struggling to heat their homes and pay their electricity bills due to high gas and oil prices. In addition, the Bank of England’s attempts to fight inflation have resulted in higher interest rates, resulting in higher mortgage costs. Some analysts, according to Goldman Sachs, are considering the possibility of widespread mortgage default as people struggle to keep up with interest payments.
Thankfully there is some good news on the horizon; the British pound has rebounded since its low of $1.04 US to trade as of this writing at $1.16. Kwasi Kwarteng, the Chancellor of the Exchequer, and Prime Minister Liz Truss have resigned. There is much hope for the new administration of Rishi Sunak, who has promised a more common sense fiscal plan to fight the cost of living crisis and inflation.