A pound sterling was just $1.035 yesterday. The venerable currency has never been so cheap. The new Prime Minister Liz Truss, of all people, had triggered the sell-off of the national currency – on the 20th day of her term of office.
That’s a debut: Liz Truss has been in office less than three weeks as British Prime Minister, when she has already sent the national currency to its lowest point in history. Since the 47-year-old took office, the British pound has fallen by 10 percent against the US dollar and by 6.6 percent against the equally weak euro. Economists don’t think Monday’s low of $1.035 is the end of the road. A parity with the US currency, i.e. a level of 1.00 dollars, is considered realistic.
The recent decline in the British currency is almost entirely to the account of the new government. Just last Friday, the new finance minister, Kwasi Kwarteng, presented his plans for the coming budget. Kwarteng wants to push through tax cuts equivalent to 60 billion euros starting next year. The last time there were such large tax cuts in the UK was in 1972.
This is to be financed with high debt. They could be gigantic. London bankers and think tanks assume costs of between 100 and 460 billion euros over the next five years. According to the figures recently published by the British government for March, the country is already plagued by a mountain of debt of 2.6 trillion euros. That’s more than Germany, even though the UK economy is smaller than ours.
Kwarteng’s plan is to boost the economy with massive tax breaks. From next year, top earners with an annual income of £150,000 or more will only pay 40 instead of 45 percent in tax. The entry tax rate falls only from 20 to 19 percent. Businesses are also being delimbed. Kwarteng hopes that the plan will help the economy grow 2.5 percent faster than planned. He himself calls his project “Big Bang 2” in reference to a package of relief that triggered London’s boom as an international financial center in 1986 under Margaret Thatcher.
Economists do not expect a similar effect from the current package from Kwarteng – on the contrary. The problem: Even with the tax cuts, there is currently no money for investments. Private households are groaning under inflation, which recently reached 9.9 percent. The Bank of England raised interest rates to 2.25 percent last week. This means that loans are becoming more and more expensive, but these are exactly what companies need to trigger the economic growth hoped for by Kwarteng and Truss.
In fact, the central bank thinks the kingdom is already in recession. In the second quarter, economic output fell by 0.2 percent compared to the first three months of the year. For the quarter ending in September, the Bank of England expects minus 0.1 percent.
The potential benefits of tax breaks therefore appear to be limited. Economists, on the other hand, estimate the potential damage to be enormous. “It’s absolutely perverse to think that if you only allow the rich to get richer then money will trickle down to everyone,” opposition leader Keir Starmer told the BBC. In fact, the “trickle-down” approach that both the US under Ronald Reagan and Britain under Margaret Thatcher followed in the 1980s has now been scientifically refuted. “A strategy of ‘trickle down’ has never worked and will not bring anything in the future either, apart from higher debts and less prosperity,” said Marcel Fratzscher, head of the German Institute for Economic Research, to “T-Online” last year.
But worse than the social dynamite contained in the tax package are the financial implications. “Stagflation and imminent need to seek help from the International Monetary Fund… Truss and her cabinet are clueless,” US economist Nouriel Roubini wrote on Twitter. “This is a big gamble that will leave Britain’s debt on unstable footing,” says Bethany Payne of London-based investment firm Janus Henderson. Even the British business association CBI, otherwise a fan of tax cuts, reacted sceptically. “A credible plan” is now needed quickly on how state finances are to remain in the green in the medium term. “We need details on that sooner rather than later.”
In the coming year, the economic situation could even worsen. Although Truss and Kwarteng want to cap energy prices and thus relieve households, there is hardly any room for investment. Analysts estimate that the Bank of England could raise interest rates to as much as 6 percent by August 2023. That would make loans so expensive that hardly any companies would be allowed to invest in expansion. Instead, a permanently stagnant economy throughout the year would be possible – and with it Kwarteng’s plans to finance the tax cuts through greater economic power.
With all these assumptions, investors now prefer to sell the British pound. The return opportunities are greater for them in other countries. Accordingly, the exchange rate of the pound falls, while the euro and the US dollar benefit.
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