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Damage Control

Britain’s new finance minister recently chose to undo almost every single one of Prime Minister Liz Truss’s tax and spending plans. British had been reeling for weeks after the PM’s plans were announced, and at least for a while there, the United Kingdom lost economic legitimacy. Despite the about-face, the fact that the plans were released in the first place has inspired doubt not only about British leadership, but the future of the country as a whole.

Setting the Scene

Inflation is roaring in Britain, where prices are rising at rates not seen since the 1980s. Because of that, the Bank of England is expected to raise interest rates in the coming months, even though doing so will almost certainly worsen the impending recession. The finance minister, Jeremy Hunt, in his third full day in office, cancelled almost every single tax cut announced by his predecessor, Kwasi Kwarteng, in September. These tax cuts were what sent the pound into a tailspin and forced the Bank of England to intervene. Additionally, Mr Hunt also walked back a cap on household energy bills that we were supposed to last through 2024. Instead, that policy will only last until April 2023 to buy time for them to release a new, less expensive plan. Bond prices responded. On Monday, the yield for 10-year bonds fell to 3.98%, significantly less than its 4.3% high just three days prior (bond prices are famous for moving in .01 increments). The pound also rose more than 2% against the dollar, back up to 1.14.

Tightening Belts

But Mr Hunt’s actions have not all been popular. Surprisingly, he also postponed a cut indefinitely to the lowest income tax rate, which many did not expect to be part of the cuts. But the finance minister defended his actions by pointing to the impending recession, stating, “it is not right to borrow to fund this tax cut”. The markets are certainly paying attention, and the message that Mr Hunt wants to convey right now is fiscal responsibility. Experts are not expecting many more improvements. Because of Truss’s disastrous policies, the markets are permanently worse off than they were just a month ago. Hunt successfully stabilised the situation, but the bar has been shifted permanently, or at least until new policies are announced, or Truss leaves office. For example, yields on five-year bonds sit at 3.94%, some .38 points higher than they were before Truss’s plans were announced.

It may take years of belt-tightening for Britain to regain fiscal credibility, something that it obtained over the decades and centuries. Not all hope has been lost, but the country is certainly in damage control mode for the foreseeable future.