Liz Truss unleashes financial chaos in the UK

Observers of the UK's political and economic scene have gotten used to chaos over the last few years. The past two weeks may well top the lot.

It's worth going back to where it began. The first meaningful policy moment for Liz Truss's new government was a "mini-budget" on September 23. The aim was to set a path to chart the country out of a range of economic crises.

The UK finance minister, Kwasi Kwarteng, announced the country's biggest tax cuts in 50 years. The rich benefited disproportionately. Among the most controversial moves were a cut to the top rate of tax for those earning more than £150,000 (€172,000, $172,000) per year, and the removal of a cap on bankers' bonuses.

Perhaps most controversial was the fact that the plans would require significant additional government borrowing at a time when the public finances were already severely stretched.

The reaction was swift and brutal. Amid resounding criticism from all sides of the political divide, the UK financial system almost immediately started to signal code red.

The British pound plunged in value, hitting a record low against the US dollar. That swoon came after Kwarteng vowed even more tax cuts following the initial £45bn package he had announced.

The cost the UK pays to borrow money on international markets rose dramatically, as investors increasingly doubted the country's financial resilience.

Amid fears that the Truss-Kwarteng plan could plunge the UK into a financial crisis, the Bank of England took emergency action less than a week after the cuts were announced. Warning of a "material risk to UK financial stability," it announced a £65 billion bond-buying program.

The situation led to the International Monetary Fund openly criticizing the UK's plans, a highly unusual move for a major economy. The IMF, which monitors global economic stability, said the plans could fuel inflation and increase inequality.

Climbdowns, U-turns, distractions

The plans lasted just over a week before the scale of the opposition and outrage became too much. On October 3, Truss and Kwarteng announced a dramatic climbdown.

"We get it, and we have listened," Kwarteng tweeted, saying that the abolition of the so-called 45p tax rate — the one which targeted top earners — would now not be going ahead.

In their media talking points, Truss and Kwarteng both repeatedly said the abolition of the top rate of tax had become "a distraction."

According to Andrew Goodwin from Oxford Economics, the issue was much clearer.

"It's the optics of cutting taxes for the rich at a time when the poor are struggling badly with high inflation, and when there are rumors that the government will uprate benefits by less than the rate of inflation," he told DW.

He does not believe that the government's U-turn will make a difference to doubts over the UK's financial position.

"This was purely a reaction to a political problem. The government realized that so many of its own MPs were opposed that the measure wouldn't attract enough votes to get through parliament. In terms of the public finances, this measure was a very small part of the problem, and questions around the sustainability of the public finances over the longer-term remain largely unchanged."

Growing pains and a risk of contagion

Since the government reversed course, the pound has clawed back some losses and UK government bond markets have also recovered.

However, faith that the Truss government can deal with the UK's fundamental economic problems appears to be shattered. During her campaign to become the leader of the Conservative party, Truss had emphasized that restoring growth to the UK economy was her primary aim.

In her speech at her party's annual conference on Wednesday, she further insisted on this priority, despite the turmoil caused by her plans.

In the aftermath of the mini-budget, several economic analysts downgraded forecasts for UK economic growth in 2023. Consensus Economics, which presents an average of forecasts, believes the UK economy will actually contract next year by around 0.3%.

At a time when the global economy is facing a range of pressures, the severity of the UK's problems has raised fears that they could spread further.

"It is like having a sand castle where bits and pieces start falling off all together," Olivier Marciot, head of investments for multi assets and wealth management at Unigestion, told Reuters "I think the UK is one of those pieces...It is just adding to the pain, adding to the stress."

However, Goodwin says he is "sanguine" about the risk of contagion from the UK crisis. "We are concerned about markets more generally and the consequences of the tightening in financial conditions that we're seeing in many economies," he said.

Whisper it: Relations with the EU have improved

The difficulties experienced by Truss in her first weeks as prime minister appear to have had an unintended positive effect on another key policy area: post-Brexit relations with the EU.

It got little attention, but this week the EU and UK resumed talks over Northern Ireland's trading arrangements for the first time in eight months. The issue has been the primary stumbling block in relations between the EU and the UK in recent times.

During her time as foreign secretary, Truss reveled in becoming one of the most ardent advocates for ripping up the deal the UK signed with the EU on Northern Irish trade, known as the Northern Ireland Protocol — a hugely controversial move that could have provoked a trade war.

However, a remarkable thaw in relations appears to have taken place, with both sides now increasingly confident that a deal can be done without the UK unilaterally exiting the agreement, as Truss has previously pushed for.

For Truss, who openly models herself on former Prime Minister Margaret Thatcher, it is another policy area where her position has had to dramatically change since she became prime minister.

Thatcher had famously said of herself: "The lady is not for turning," when referring to demands that she perform a U-turn on her economic policies. Yet U-turns have already become a major part of the Truss premiership

Edited by: Ashutosh Pandey