The brief tenure of Liz Truss as Prime Minister of the United Kingdom was marked by significant economic upheaval, most notably a sharp decline in the value of the British pound. While her resignation on October 20th, 2022, triggered a temporary rise in the currency, the underlying reasons for the pound’s weakness during her leadership remain crucial to understand the market’s reaction and the broader economic context. This article delves into the factors that contributed to the pound’s fall under Liz Truss, providing a comprehensive analysis for an English-speaking audience seeking to grasp the complexities of this financial event.
The immediate market reaction to Truss’s resignation was positive, with the pound briefly rising against the dollar to $1.13 before settling around $1.12. This initial surge indicated investor relief at the departure of a leader whose economic policies had triggered considerable market anxiety. However, this momentary uplift does not negate the preceding period of instability and the fundamental issues that led to the pound’s vulnerability.
The core catalyst for the pound’s decline was the announcement of the “mini-budget” by Truss’s government. This fiscal plan, unveiled shortly after she assumed office, proposed substantial unfunded tax cuts. The scale of these cuts, combined with a lack of clarity on how they would be financed, sent shockwaves through financial markets. Investors became deeply concerned about the sustainability of the UK’s public finances and the potential for increased government borrowing.
The promise of significant tax reductions without corresponding spending cuts or identified revenue streams raised serious questions about fiscal responsibility. The markets interpreted this as a sign of economic mismanagement and a potential threat to the UK’s financial stability. This perception of increased risk led to a sharp sell-off of the pound as investors sought safer assets.
A weakened pound has direct consequences for the UK economy. It increases the cost of imports, making goods and services from overseas more expensive for UK businesses and consumers. This inflationary pressure can exacerbate the cost of living crisis, as companies may pass on these higher import costs to their customers. For individuals, a weaker pound reduces purchasing power abroad, making international travel more expensive.
Prior to Truss’s resignation, the pound had already plummeted to a record low against the dollar in the wake of the mini-budget announcement. Simultaneously, government borrowing costs, reflected in gilt yields (the interest rate on UK government bonds), soared. Investors demanded higher returns to compensate for the perceived increased risk of lending to the UK government.
The Bank of England intervened with an emergency bond-buying program to stabilize the market and prevent a collapse in gilt prices. Subsequently, Jeremy Hunt, the new Chancellor of the Exchequer appointed after the sacking of Kwasi Kwarteng, reversed almost all of the mini-budget’s measures. This partial U-turn helped to calm market anxieties to some extent, but the damage to the UK’s economic credibility had already been done.
Economic analysts highlighted the sense of relief in the markets following Truss’s resignation, acknowledging the immense economic and fiscal challenges facing the UK. However, they also emphasized that much more needed to be done to restore long-term stability and investor confidence. The new Prime Minister and Chancellor would face the daunting task of navigating the cost of living crisis, rising borrowing costs, and a significant crisis of credibility.
The market reaction, while initially positive, was described as “muted” by some economists, indicating a cautious optimism. Investors were waiting for concrete details of the new government’s economic plan and a clear demonstration of fiscal responsibility. The rapid Conservative leadership contest underscored the urgency for a stable political environment to underpin economic recovery.
Business leaders emphasized the erosion of confidence in the UK’s economic management due to the political turmoil of recent weeks. They called for the swift delivery of a credible medium-term fiscal plan and a long-term strategy for economic growth to reassure businesses, markets, and global investors.
Analysis box by Faisal Islam, economics editor
In essence, Liz Truss’s downfall was intrinsically linked to her economic policies. The mini-budget, intended to stimulate economic growth, backfired spectacularly due to its lack of fiscal prudence and the resulting loss of market confidence. Her leadership mandate was fundamentally undermined by the failure of this economic experiment, played out on a global stage.
The focus shifted from the intended benefits of an energy guarantee to the fallout from the unfunded tax cuts. Market concerns overshadowed any positive news, such as potential declines in European gas prices or global inflation trends. Even the reversal of corporation tax cuts and the dismissal of the Chancellor could not fully restore faith in the government’s economic direction.
The political instability further exacerbated the economic uncertainty. The question remained whether Truss’s resignation would mark the end of this instability or potentially worsen it, depending on the nature and policies of her successor.
The yield on 10-year UK government bonds, a key indicator of borrowing costs, reflected this market turmoil. It initially spiked above 4% before declining as speculation about Truss’s departure intensified. While it edged up again after her resignation statement, it remained below the day’s peak, indicating a degree of market stabilization but still elevated borrowing costs.
The mini-budget had fundamentally damaged confidence in UK government bonds, leading investors to demand significantly higher interest rates to compensate for the increased perceived risk. This surge in yields highlighted the severity of the market’s negative reaction to Truss’s economic policies.
Prior to the resignation, market commentators described a sense of “stunned, open-mouthed horror” at the unfolding political and economic events. The core issue was the destruction of the perception of “political competency,” a vital element for a functioning economy. Restoring this competency and rebuilding trust became the paramount task for the next leader to stabilize the pound and the broader UK economy.
In conclusion, the fall of the pound under Liz Truss was a direct consequence of her government’s unfunded tax cut plans, which triggered a crisis of confidence in the UK economy. While her resignation offered a temporary respite, the underlying economic challenges and the need to restore fiscal credibility remained significant hurdles for her successor. The episode serves as a stark reminder of the critical importance of sound fiscal policy and market confidence in maintaining currency stability and overall economic health.
