British Prime Minister Liz Truss’s plan to slash taxes and drive up government borrowing has managed to upset almost every corner of the financial world and prompt growing calls for her to reverse course.
Since the tax plan was announced last Friday, a chorus of voices has come out against it, ranging from the International Monetary Fund to credit-rating agencies, economists, pension funds and British homeowners who could see their monthly mortgage payments rise by as much as 70 per cent in the coming months.
In a blunt rebuke of the government, the IMF said late Tuesday that given rising global inflation “we do not recommend large and untargeted fiscal packages at this juncture.” It also urged Chancellor of the Exchequer Kwasi Kwarteng “to re-evaluate the tax measures, especially those that benefit high-income earners.”
On Wednesday, Moody’s said the plan raised questions about the credibility of the government’s fiscal strategy and added that “large unfunded tax cuts are credit-negative,” suggesting a potential downgrade to the country’s credit rating.
Some economists were even more scathing. “This is by far the worst unforced economic policy error of my lifetime,” said Torsten Bell, chief executive officer of the London-based Resolution Foundation, an economic think tank.
Investors have signalled their disapproval as well by driving down the value of the British pound to near parity with the U.S. dollar and pushing up yields on government bonds, which are used to set interest rates on mortgages and other loans.
The yield on the benchmark 10-year bond jumped as high as 4.6 per cent on Wednesday, the highest level since the financial crisis of 2008. Yields move inversely to prices, which means that investors have been bidding down the price of bonds and demanding a higher interest rate in return.
The Bank of England had to intervene on Wednesday after falling prices on long-term bonds, stretching out 20 to 30 years, forced some pension funds to sell assets in order to meet cash collateral requirements. The central bank said it would start buying long-term bonds over the next couple of weeks to help bring down yields.
“Were dysfunction in this market to continue or worsen, there would be a material risk to U.K. financial stability,” the bank said in a statement. “The purpose of these purchases will be to restore orderly market conditions.” It didn’t say how much it would spend on the buyback, but indicated that “the purchases will be carried out on whatever scale is necessary to effect this outcome.”
The bank’s move managed to halt the decline in bond prices, but the pound fell almost 0.5 per cent to US$1.067. It finished the day at $1.075. Sterling hit an all-time low on Monday of US$1.03.
The big political risk for Ms. Truss is the impact all of this is having on people trying to pay off their mortgages and other loans. Ms. Truss took over from Boris Johnson as Conservative Party Leader and Prime Minister less than a month ago and she has been eager to set out what she hoped would be a bold agenda based on free-market principles.
But the tax plan, and the lack of specifics about how to pay for it, has caused havoc in the mortgage market and left millions of Britons facing soaring interest payments.
Interest rates are now expected to climb to 6 per cent by next summer, up from the current Bank of England rate of 2.25 per cent and 0.1 per cent last December.
The majority of mortgages taken out in Britain carry fixed-term rates of five years or longer, but around one-third are for 24 months or less. The trade body for the financial services sector, U.K. Finance, has estimated that 1.8 million of these short-term mortgages are scheduled to expire next year. Another one million people hold variable-rate mortgages which are also vulnerable to a jump in rates.
“If mortgage rates rise to 6 per cent – as implied by markets’ current expectations for bank rate – the average household refinancing a two-year fixed rate mortgage in the first half of 2023 will see monthly repayments jump to £1,490 ($2,200), from £863,” said Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics. “Many simply won’t be able to afford this.”
The financial turmoil has gotten so severe that many lenders have temporarily pulled their mortgage products until they can be repriced. According to Moneyfacts, an online service that tracks loans, Tuesday saw the biggest daily drop ever in the number of mortgage products registered on the site.
Even more troubling for Ms. Truss is the plunging support for the Conservatives. A YouGov poll released this week put the opposition Labour Party 17 points ahead of the Tories, the largest Labour lead since Tony Blair’s landslide victory in 2001. Other polls have found widespread public disapproval for much of the tax plan, which many people view as favouring the wealthy.
“The Conservatives have suffered a dramatic collapse in the polls of late, although that began before the arrival of Liz Truss,” said Matthew Goodwin, a professor of politics at the University of Kent.
“One of the fundamental problems that Liz Truss faces is that her economic strategy, so-called Trussonomics, of cutting taxes while increasing borrowing, is not particularly popular in the wider country.”