Opinions Joost Derks
Exciting balancing act for the British pound
A balanced mini-budget could give the pound a boost. If the budget deficit widens significantly, confidence in the currency could evaporate. On the other hand, an overly tight fiscal policy is also detrimental to the pound, which faces a tense period.
British Chancellor of the Exchequer Rachel Reeves's visit to the annual conference of the IMF and the World Bank last week marked the start of a potentially turbulent ride leading up to the presentation of the autumn budget. History shows, however, that this is anything but a formality. In 2022, for example, Prime Minister Liz Truss suffered a spectacular setback after presenting a so-called mini-budget that threatened to significantly increase national debt. This caused investors to lose confidence in British fiscal policy. They demanded a higher risk premium on UK government bonds, causing long-term interest rates to soar and the pound to plummet. Having lost her credibility overnight, Truss had little choice but to resign.
Brexit as the culprit
That budget blunder still reverberates through international politics. Earlier this month, immediately after her victory in the party elections for Japan's leading LDP party, Sanae Takaichi emphasized that she is no Liz Truss. For now, Reeves's strategy is primarily to portray the Conservative Party as the main cause of the budgetary challenge the United Kingdom now faces. During the IMF meeting, she emphasized that British productivity had suffered a 4% dent due to leaving the European Union. Brexit was initiated by the Conservatives, while Reeves's Labour Party wants to strengthen trade with Europe.
Raise taxes
Over the next month, however, Reeves will have to speak her mind about the budget. Last year, she announced £40 billion in additional taxes, which she hopes will prevent the future deficit from rising too much. A sound fiscal policy also helps to further restore the confidence of financial markets. On the other hand, Reeves must resist the temptation to raise the tax burden further than necessary. This is politically sensitive, especially at a time when Nigel Farage's right-wing UK Reform Party is performing well in the polls.
Big tears in clothes
Reeves' plans also partly determine the pound's direction. If she loosens the financial reins too much, investors will worry and the pound will plummet. If she raises taxes too much, it could slow economic growth. In that case, the Bank of England will be more likely to lower its policy rate. And a lower interest rate also doesn't bode well for the British currency. It will take a considerable balancing act to give the pound a boost. Moreover, there's still the risk that inflation figures for the service sector, released next Wednesday, will throw a wrench in the works. It remains to be seen whether the pound will make it through the New Year unscathed.
Joost Derks
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