UK’s Sudden Tax Slashing Plans Put Currency, Treasury Bonds on the Line

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With the UK economy a hot mess, Liz Truss is channeling her hero Margaret Thatcher and her pal Ronald Reagan with a little trickle-down economics.

Markets were unimpressed with the 80s throwback act. They enter the week on edge after the UK’s new steadfastly conservative government under the libertarian-leaning prime minister announced massive tax cuts Friday.

In Liz We Truss

The IMF and the OECD believe the UK will post the slowest growth of the G7 economies next year (the OECD predicted zero growth). But any sense of urgency was decorously put to one side as the country’s new Truss-led government, sworn in on September 7, spent its first weeks occupied by the memorial services for Queen Elizabeth II. Now, Chancellor Kwasi Kwarteng is down to business.

The tax-axing was the nation’s biggest in 50 years. The top income tax bracket in the UK, a 45% rate on earnings over £150,000 a year, will be gone. And farewell to the banker bonus cap, which limits banker bonuses to double their salary. Truss and Kwarteng, both fans of 80s conservative stalwarts Thatcher and Reagan, cite trickle-down economics to argue tax cuts at the top will benefit all by boosting growth. Markets are not yet convinced:

  • After the plan was announced, the pound fell to its lowest since 1985 and the yield on 10-year UK bonds rose more than 30 basis points to 3.83% (and a record 51 basis points on five-year notes). Higher yields could dramatically increase the estimated £400 billion ($434 billion) in borrowing needed over the next five years to finance the tax plan, according to the Resolution Foundation.
  • Inflation is still at the highest levels in a generation, with more rate hikes from the Bank of England expected to fight it and raise borrowing costs. Traders have priced 120 basis points of rate hikes when the BoE meets in early November and, Trevor Pugh of brokerage Tradition told Bloomberg News, traders are also pricing in a possible intra-meeting hike.

Trading Places: Truss admitted last week that the post-Brexit UK is unlikely to begin talks with the US about a trade agreement until the “medium term.” The UK is America’s seventh-largest trading partner, with $118 billion in total trade value, and US officials are more focused on $600 billion in trade relationships with Canada, Mexico, and China.

Rebel Rebel: The Telegraph reported Sunday that, if the pound falls below the dollar, Conservative MPs plan to launch a rebellion against Truss. If they don’t like the plan now, “There’s more to come,” Kwarteng told the BBC on Sunday.