The British pound reached record-low values against the USD this past week, the latest in a series of economic headwinds buffeting the country. The UK already faces high material living costs, largely attributed to rising inflation, and recessionary fears have acted as a downside risk for sentiments and spending.
The sharp plummet in the pound occurred after the Truss government announced a ‘mini budget’ in efforts to battle recessionary pressures. The centrepiece of this were sizeable tax cuts. Notably the trifold effects of COVID-19, the Russo-Ukraine war and the hangover effects of exiting the EU posed significant risks to consumption, with the budget intending to inject some spending stimulus back into the economy. Additionally, part of the rationale behind the policy could be politically motivated, with Truss’s campaign promising tax cuts. All this have rattled investors with a brutal reality check of the UK’s economic woes, despite incremental downward adjustments of the pound occurring for quite a while.
The policy announcement comes with many risks. For one, it will damage the government’s bottom line as it widens its appetite for debt. This all comes with the opportunity cost of austerity and consolidation later down the line. In addition, spending stimulus is problematic in the context of high inflation. With the inflation rate sitting at 9.9%, the extra demand pressure could realistically spiral prices out of control and begin to threaten stagflation. Indeed, as with many other economies around the world, what’s needed is a fine balancing act between monetary and fiscal levers in the economy. At the moment, competing forces in both policy organs have induced economic instability, insubstantial disinflationary effects and widening inequality in outcomes, all undesirable effects.
So what does it mean for the UK’s favourite penal colony down under? A weaker pound means higher purchasing power for the Australian citizen, so tourism and importing is favourable. Nonetheless, on the flipside, export demand and inbound investment is likely to suffer as sentiments decline. With real investments being the largest linkage between the two economies, this could well have residual effects in Australia.