In a note titled “Crunch time for sterling”, published on the day Truss won the Conservative leadership race, Deutsche Bank currency analyst Shreyas Gopal said a large, unfunded and untargeted package of tax cuts and spending commitments could worry global markets. It could lead to foreign investors refusing to finance the UK’s external deficit by buying government debt, as investor confidence “cannot be taken for granted”, says Deutsche. Gopal pointed out that the UK’s current account deficit is already at record levels, meaning sterling needs large capital inflows, supported by improving investor confidence and falling inflation expectations to support of the currency. “However, the opposite is the case,” wrote Gopal. “The UK is suffering from the highest rate of inflation in the G10 and a weakening growth outlook.” The UK current account measures the difference between the UK’s imports and exports of goods and services, and between the UK’s investment abroad and the returns foreigners make on their investments in the UK. It reached a record 7.1% of GDP in the first three months of the year. Inflation expectations could rise further if the Trus administration changes the Bank of England’s inflation-fighting mandate, as suggested during the leadership race. “A balance of payments financing crisis may sound extreme, but it is not unprecedented: a combination of aggressive fiscal spending, a severe energy shock and the slide of sterling finally led the UK to resort to an IMF loan in the mid-1970s.” , said Gopal. When he was governor of the Bank of England, Mark Carney described Britain as dependent on the “goodwill of foreigners” to finance its current account deficit. In September 1976, with the pound at an all-time low, James Callaghan’s Labor government approached the IMF for a $3.9 billion loan – the largest ever requested from the fund at the time. This crisis followed the “Barber Boom” of the early 1970s, when Conservative Chancellor Anthony Barber cut taxes in a boom that weakened the pound, leading to stagflation following the OPEC oil crisis. The Trust could scare off foreign investors if it triggers Article 16 of the Northern Ireland Protocol to override parts of the treaty after Brexit. “Taking emergency measures around the Northern Ireland Protocol could increase uncertainty about trade policy. With the global macroeconomic environment so uncertain, investor confidence cannot be taken for granted,” Gopal warned. During the campaign, Truss promised to reverse the recent rise in national insurance and scrap the rise in corporation tax. Her team also suggested that VAT could be cut by five percentage points to help households. Truss promised on Monday to implement a “bold plan to cut taxes and grow our economy” and tackle energy bills. A price freeze on some energy bills could cost tens of billions of pounds, adding to the UK’s borrowing needs, unless it is accompanied by tax rises. Subscribe to Business Today Get ready for the business day – we’ll point you to all the business news and analysis you need every morning Privacy Notice: Newsletters may contain information about charities, online advertising and content sponsored by external parties. For more information, see our Privacy Policy. We use Google reCaptcha to protect our website and Google’s Privacy Policy and Terms of Service apply. HSBC warned that Truss is facing an “extremely difficult time”, due to the energy crisis affecting households, businesses and public services. They estimate that the UK could borrow £87bn more than expected this financial year. This includes the £17bn of tax cuts Truss promised during the campaign – rising to £29bn next year – £35bn of extra support for households and businesses, including a possible freeze on energy bills, and a further £25bn to service the debt. “In normal recessions, this can be expected. But this is not a normal recession: the BoE is raising interest rates and is about to start selling bonds,” said Elizabeth Martins, senior economist at HSBC. “And the prospect of feeding demand is more complicated than it was in, say, the global financial crisis. This time, it risks keeping inflation higher, forcing the BoE to push for more rate hikes.” The UK government’s borrowing costs have already risen sharply in recent weeks amid a wider divestment of government debt. The yield, or interest rate, on the 10-year note is the highest since late 2013, at nearly 3%, and rose by the most since 1986 in August. “If investor confidence erodes further, this dynamic could become a self-fulfilling balance of payments crisis, where foreigners would refuse to finance the UK’s external deficit,” says Gopal. The pound fell to a near 37-year low on Monday as the shutdown of Russia’s Nord Stream 1 gas pipeline added pressure to the UK and European economies. Sterling fell to $1.14 against the US dollar, its lowest level since March 2020. Wholesale gas prices rose sharply, erasing some of last week’s losses, with the UK contract for next month up more than 10% in afternoon trade at 455p per heat, more than three times higher than ,what a year ago.
