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Liz Truss is set to become UK prime minister this week with her plan to "turbo-charge" the economy by slashing taxes already worrying investors amid double-digit inflation.
The foreign secretary is the front-runner to replace Boris Johnson, and Conservative Party members are expected to name her as their leader on Monday.
She would take office after declaring a willingness to run up the budget deficit just as the Bank of England is raising interest rates and selling its own holdings of government bonds. She also has indicated she will review the central bank's mandate.
Markets have already signaled concern about a Truss premiership as bond traders fret that a flood of gilts may be too much to absorb, triggering higher debt-servicing costs.
Since July 7 when Johnson decided to step aside, borrowing costs on 10-year government bonds have risen faster than those of any of the other 22 major bond markets. The pound has also trailed 132 of the world's 150 top currencies.
"We have a number of concerns about the dependence on the kindness of strangers to fund the UK when the public finances are likely to deteriorate materially," said Mark Capleton, strategist at Bank of America Corp.
Few leaders have taken charge of the UK with the economy in as dire a state. The most comparable moment is the early 1970s, when Labour's Harold Wilson entered Downing Street after an oil-shock and miner strike that left industry on a three-day week.
Should Truss win, she'd inherit inflation at 10.1% and on track to breach 20% for the first time since 1974, according to Goldman Sachs Group Inc. Investors are betting interest rates rise to 4.75% by May, threatening misery for mortgage borrowers more familiar with rates below 1%.
Energy costs are set to absorb as much as a 10th of household spending, pushing as many half of the UK's 28 million households into fuel poverty.
With the BOE expecting a recession by the end of the year, industry has also been told to prepare for orchestrated blackouts this winter. And labor groups are talking about the first nationwide strike since 1926.
Truss's view is that cutting taxes and regulations will unleash the nation's productive potential and take advantage of the opportunities opened when Britain left the European Union.
Her plan is to make the public sector "more efficient" and bring the public finances under control by raising the UK's average growth rate to 2.5% -- a level not consistently achieved since before the 2008 financial crisis. That will fix the public finances by bringing debt as a share of GDP down in the longer term.
She's been deliberately vague about the details, but in broad terms it has three prongs:
Tackle the immediate cost-of-living crisis with support for households and business
Kick-start growth with £30 billion of personal and business tax cuts
Lift the productive potential of the economy with supply side reforms. The details, though, remain largely a mystery
What Bloomberg Economics Says ...
"Staking out a libertarian position, Truss's plan to cut taxes will offer little support to those hardest hit by the deepening energy crisis, while creating additional long-term pressure on the public finances."
--Ana Luis Andrade, Bloomberg Economics. Click for the INSIGHT.
Read more: Even Liz Truss Supporters Worry She Could Wreak Havoc for the UK
Economists, opposition politicians and even some in the ruling Conservative Party worry that her tax cuts will be inflationary and loosen fiscal restraints too much, turning the market downturn into a crisis. She has pledged "no new taxes" to pay for the giveaways and says she does "not want to cut public spending" either.
Former Bank of England Deputy Governor Charlie Bean, who was also a member of the government's fiscal watchdog, the Office for Budget Responsibility, believes launching a policy experiment in the middle of a crisis is unwise.
"I could see investors starting to think the UK doesn't look such a good place to invest," Bean told Bloomberg Television. "You'll see a risk premium re-emerging on gilts, which is just starting to happen."
His fear that investors could lose faith in the UK is shared by Nicholas Macpherson, the Treasury's former permanent secretary, who tweeted this week that "a rising cost of borrowing and a falling pound" is the Treasury's "worst nightmare."
Plans to review the BOE mandate are causing further unease. The Treasury handed the central bank authority over interest rates in 1997, but Truss has suggested the government needs more directive powers. If she follows through, it could dent investor confidence in the institution.
Taken individually, none of Truss's policy proposals are extraordinary. Her promise to reverse April's increase in national insurance and scrap next year's planned rise in corporation tax merely put tax policy back where it was at the start of 2020. The UK has reviewed the BOE mandate before, and Canada does it regularly.
But in the context of the current energy and inflation shock, and set against populist language about breaking from "economic orthodoxy," Truss has people worried.
"UK government finances are a source of worry," said Lauréline Renaud-Chatelain, a fixed income strategist at Pictet Wealth Management. "The deficit is very likely to rise meaningfully going forward."
The Treasury is facing extreme strains. Support for households may top £50 billion, according to Sanjay Raja, UK economist at Deutsche Bank. Others suggest more than £100 billion will be needed to save businesses from bankruptcy and offset the rise in household bills.
As rates and inflation rise, the cost of servicing the national debt will jump to around £100 billion this year -- twice the sum spent on transport.
Truss's real test will come as investors respond to the new prime minister's first remarks in the next few days. As Bean, the former BOE economist put it, "Markets are the mechanism that punish bad policies."
Even Liz Truss Supporters Worry She Could Wreak Havoc for the UK
Liz Truss Is On Course for a Collision With UK Economic Reality
Liz Truss Tax Cuts May Push Rates Closer to UK's Pain Threshold
UK's Outsider Economists Question Radicalism of Trussonomics
Truss vs. Sunak: Where UK Leadership Contenders Stand on Economy
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