October 27, 2022
Chaos Rules, Britannia?
On one level, the resignation of UK Prime Minister Liz Truss is a peculiar British story, featuring a leader who climbed to power on the votes of just 81,326 party members and then governed with the subtlety of a stoned teenager.
Yet on another level, Truss’s implosion after six tumultuous weeks raises an almost universal question. When politics goes badly, how do economies react?
When criticising a politician, it’s difficult to avoid the appearance of making a political point. But the facts in this case are obvious. This was one of the biggest and most damaging market reactions to a policy announcement in recent memory.
The sales pitch was that she would be another Margaret Thatcher. Had she channeled her radicalism into pro-growth deregulation, she might just have delivered. The would-be Iron Lady ended up as Lettuce Liz, with the press comparing her political longevity to the shelf life of green veg.
What baffled investors — not just abroad but those living in the UK as well — was why a nation usually viewed with respect for its probity and rigour where financial matters are concerned would unveil a set of tax-cutting and other interventions that were not funded. It was the sort of throw of the switch that you associate with a new, revolutionary regime than with familiar, reliable old Britain.
Britain’s sudden descent into crisis only days after Queen Elizabeth II death, laid bare the fragility of several of their most important institutions, including the prime minister, the Treasury, the Bank of England, the Conservative Party, and the nation’s asset management industry. The implications spread much further than British shores. Bond prices in countries as different as the US and Italy veered in response to each fresh move in UK gilts, and each news story out of Britain.
Those were the global-size stakes as Britain faced a deadline after three weeks of political and financial turmoil that drove the 30-year gilt, a keystone of global finance, to drop more than 20%, gain almost all of it back, and then fall 20% again. Traders of the pound sterling administered a huge blow to the national pride. The GBP briefly took out an all-time low against the dollar that had stood since early 1985, when Margaret Thatcher was prime minister. The record was GBPUSD 1.0545, which later went down as far as GBPUSD 1.0350 before it caught a bid. All of this started with the September 23rd “mini-budget” by newly installed finance minister Kwasi Kwarteng that featured a plan for unfunded tax cuts. Markets revolted, and weeks of chaos ensued.
Stabilising the markets
In a bid to save her premiership, Truss had to fire her swashbuckling finance minister, Kwasi Kwarteng and replace him with the even-keeled Jeremy Hunt. Where Kwarteng had announced tax cuts, and then wildly promised more of them, Hunt cancelled them with algorithmic calm. Bringing in a swift end to the Kwarteng-type programme — #kamikwaze economics, as the Twitterati called it — was off the table.
The grown-ups at the Bank of England had to stand tall. Remarkably, they managed to stabilise the markets without harming their inflation-fighting credibility: They propped up long-term government bond prices, which meant cutting long-term interest rates, while also signalling continued hikes in the short-term interest rate to get inflation down.
By keeping the bond intervention brief, they executed this accelerate-brake double act without blowing the engine. Other central bankers, who may be forced into similar manoeuvres during the looming global economic turbulence, must feel relieved that this worked.
What are the lessons for everyone else?
As one of the most influential economies in the world, any move it made was bound to cause ripples in the markets. This though, was Britain provoking a series of earth-shaking tremors rather than a few gentle waves. Other countries were trying to deal with war, pandemic, inflation. Then along came Britain with an extra ingredient to lob into the mix. Sly digs apart, other nations vented their frustration. US President Joe Biden called it a “mistake” and said it was “predictable” that Truss would have to backtrack.
As we write, the UK has since announced its new Prime minister – Rishi Sunak. Ten-year gilt yields are now equal to their lowest point since Kwasi Kwarteng’s “mini-budget” of September 23rd which sent gilt markets into meltdown. They are still, however, some 50 basis points higher than they were at the beginning of mini-budget week, which started with Queen Elizabeth II’s funeral.
So far, it looks as though the party grasps that it cannot afford any more feuding, and that it looks ridiculous. That means the chances of relatively dull and undramatic technocratic governance for the next two years look strong. That may not be what a majority of Britons voted for, but it will certainly sound good to the markets.
To speak to an expert, please contact us at firstname.lastname@example.org or +27 21 203 0081.
SPEAK TO AN EXPERT