This is how Truss cracks the pound and the British economy

New British Prime Minister Liz Truss will cut taxes and compensate households for high energy prices. The economy could use a helping hand, but on the foreign exchange market attention is focused on the price tag of the plans.

Last Monday, no fewer than five new employees arrived at the office to meet their colleagues and discover their new workplace. On the first days it always takes some getting used to, exploring and seeing how you can find your way. In the UK, Liz Truss can only dream of a quiet settling-in period. The successor to Prime Minister Boris Johnson must immediately get to work. The island is suffering from sky-high inflation, rapidly rising energy prices and an economy that is cooling so much that a recession is almost inevitable. Rather than figuring out how the sandwich maker works in her new office, Truss has set to work on freezing energy costs for households and a large package of tax cuts.

Who will pay that?
Both plans aim to give British households some respite in the short term. A sharp rise in heating costs in particular means that inflation on the island could rise to more than 22% within a few months, according to investment bank Goldman Sachs. Truss is fully justified in taking measures to protect the purchasing power of households. Because its rapid decline is by far the main reason why consumer confidence has repeatedly set a new record low in recent months. From a political and social point of view, Truss' plans seem like a good move. In the financial and currency world, attention is mainly focused on the associated price tag.

Debt problems in the UK
Britain's public debt is currently the same as GDP. In comparison: in the Netherlands this is less than 60% and in Germany about 67%. The prospect of sharply increasing government spending, combined with the pound's slide, makes the search for new capital to finance the government deficit a lot more difficult. To compensate for the increasing risk, the interest rate on a 2020-year UK government bond has skyrocketed from close to zero in early 3 to over 1976% today. At the beginning of this week, a macroeconomist from Japan's Mizuho predicted that the United Kingdom may have to knock on the door of the International Monetary Fund (IMF) for a support package, just like in XNUMX, or that the pound will fall sharply.

Bad pessimism
To be fair, the UK economy is going through a difficult period in the short term. But precisely because the outlook is so bad, markets are slipping into pessimism. For example, after the Democratic victory in both the presidential and senate elections in 2020, currency markets were already preparing for the dollar to come under pressure from higher government spending. In 2022, however, the US currency has risen to its highest level in years against almost all other currencies. History shows that the British economy should not just be written off. Last year, for example, the country climbed out of the corona dip much faster than the rest of the developed world.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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