How did the pound (GBP/USD) react?

Truss says she will deliver tax cuts and address the energy crisis gripping the UK – Photo: Shutterstock

Sterling turned around on Monday, reversing some of its earlier losses to return to the flatline after Britain’s Conservative Party announced its new leader and Prime Minister would be Liz Truss.

The pound had, in early trade, been around 0.4% lower versus the dollar (GBP/USD) as a deepening of the European energy crisis saw risk appetite collapse across global financial markets.

Following Truss’ victory speech, the pound rallied to stand flat on the day, before dipping back. By early afternoon in London GBP/USD was 0.1% lower at $1.1492.

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Tax cuts to come

Truss underlined her mission statement that was central to her campaign: “I will deliver a bold plan to cut taxes and grow our economy.”

Indeed, Truss had said she will reverse April’s National Insurance hike and cancel the rise in corporation tax that was slated for April.

Paul Dales, chief UK economist at Capital Economics, said he believed that such fiscal loosening could result in higher inflation and higher interest rates.

“Truss has always pledged a bigger loosening in fiscal policy than Rishi Sunak and the latest rumours are that she’s preparing a package worth £70-100bn, or 3-4% of GDP,” he said.

Nigel Green, chief executive of global financial advisory firm deVere Group, explained further: “They blow an enormous £170bn hole in Britain’s finances, and would push up inflation by increasing money growth, prompting more aggressive interest rate increases from the Bank of England as it struggles to control inflation, which is still at a 40-year high.”

Roberto Cobo, chief FX strategist at BBVA, added: “Truss’s proposals are perhaps more appropriate to tackle the UK’s cost-of-living crisis in a more immediate manner, and her victory should be more market-friendly and supportive of the GBP in the short run.”

Dales concluded: “This increases the upside risks to our forecast that interest rates will rise from 1.75% now to a peak of 3%.”

Energy crisis

Truss also pledged to deliver on the energy crisis, “dealing with people’s energy bills, but also dealing with the long-term issues we have on energy supply”.

However, markets don’t act on such long-term views, and were showing signs of deep stress on Monday. Stock markets in Continental Europe were down sharply and the dollar hit fresh 20-year highs after European natural gas prices soared 30% in response to Russia’s shutdown of its Nord Stream 1 pipeline.

Cobo at BBVA concluded: “Global market sentiment and the domestic macro context should remain the key drivers for sterling.”

Bank of England independence

Forex markets had also been jittery over concerns the new leadership could tamper with the Bank of England’s remit.

Earlier in her campaign, Truss had indicated she could possibly investigate the Bank of England and its independent role in setting monetary policy. She had been critical that the Bank had been slow to react to soaring inflation.

She made no mention of this in her victory speech and in recent weeks had backed down from her hawkish stance on the UK’s central bank.

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