The Fall of Lizz Truss and the UK Bond Market Crisis
On September 6, 2022, Lizz Truss was inaugurated as the third female prime minister of the UK after being elected by the conservative party to replace Boris Johnson. Her promise was simple: to revamp the economy via tax cuts and reform. However, after only 50 days in office amidst a government crisis, Truss resigned, making her the shortest-serving prime minister in the United Kingdom’s history. So what exactly happened to the United Kingdom during Truss’s administration and what led to her resignation?
The Crisis
The United Kingdom was in crisis in July 2022 when the Chris Pincher scandal resulted in the resignation of members of the Conservative Party and Boris Johnson. At the time of his resignation, Johnson left the UK economy in a crisis as it dealt with high inflation and a weak British pound mainly due to COVID-19 and Brexit, with the country being on the brink of a recession. This created a heavy task for Johnson’s successor, who would be pressured to reverse the skyrocketing energy costs, reduce inflation, and end the food crisis sparked by the Russian invasion of Ukraine. In the July–September 2022 Conservative Party leadership election, Lizz Truss defeated Rishi Sunak and immediately promised economic reforms as well as dealing with the energy crisis and revamping health services.
Truss’ Solution
On September 23, 2022, Truss announced sweeping tax cuts in a controversial mini-budget. The goal of these tax cuts was to encourage spending in businesses which would grow the economy. Items within the budget included the cancelation of rises in corporation taxes and national insurance contributions, abolishment of the 45% top-income tax rate, and cutting of the basic rate of income tax. However, the mini-budget was criticized by many including the IMF, Joe Biden, and much of the general public.
Only three days later on September 26, British bond prices collapsed due to fears of the Bank of England taking emergency action to stabilize the British Pound. People no longer wanted to hold Gilts when the British economy was at risk of further inflation. The Bank of England was going to buy back bonds, which would increase the amount of liquidity in the markets and decrease the value of the British pound. This diminished return on bonds which led to investors selling their bonds before things got worse.
Once people started to sell their bonds, it started a chain reaction and led to others selling their bonds too. People sold their bonds in panic as the value of the Pound dropped to a record low against the U.S. dollar, reaching levels dating back to 1965. As people sold off their bonds, bond yields soared. Bond yields move inversely to bond prices, meaning that as bond prices fell, yields rose. Two-year gilt yields reached a high of 4.533% while the five-year gilt yields reached a high of 4.503%. As a result, the Bank of English expanded its rescue plan and expanded its emergency bond-buying program. This was to increase demand in the bond market which would prevent the bonds from further collapsing as the sell-off continued. British finance minister Kwasi Kwarteng would move forward fiscal-policy announcements to October 31 in order to reassure investors that action would be taken to reduce inflation in the economy. The fiscal policy would include plans to reduce debt by increasing taxes and cutting spending.
Many attribute the bond market collapse to Truss’s recent tax cuts. Truss’s tax cuts were unpopular because they contributed to inflation which was already a major sore point of the UK economy. This is because when taxes are reduced, people have more money to spend, which increases the demand for goods and results in inflation. Truss’s tax cuts, along with the large fiscal deficits during a time when inflation remained strong, was a massive red flag for investors as these policies are the opposite of what people expect in the efforts to tame inflation. The Bank of England was already tightening monetary policies to cool down the economy only for Truss to make the whole situation even worse. When Truss took office in September 2022, CPIH (Consumer Prices Index including owner occupiers' housing costs) inflation rate increased to 13.2%, up from 13.0% in August.
Fallout
The introduction of the mini-budget along with the bond market collapse resulted in a huge drop in support for Truss and the Conservative Party. Succumbing to the pressure, Truss reversed the tax cuts on October 14 and fired finance minister Kwasi Kwarteng. These decisions were welcomed by the markets with the pound rising 2.3% by the end of the day.
However, many people, including members of the Conservative Party, pressured Truss into stepping down. Truss’s poor performance as a prime minister along with the economic chaos she created was too great to be forgotten, and on October 20th, she resigned. In her final statement, she said “I recognize though, given the situation, I cannot deliver the mandate on which I was elected by the Conservative Party. I have therefore spoken to His Majesty the King to announce that I am resigning as leader of the Conservative Party.”
In appealing to the public, Liz Truss failed to consider the basic economics which lead to her downfall. Lowering taxes for the public may at first seem like a great thing for the public, but its effects can be disastrous when implemented in an inflationary environment and when the country is on the brink of a recession. If we can all learn a thing or two from Truss’s mistakes, we should always think of the bigger picture and potential consequences when making a decision.