The Old Lady is in a sticky spot. Inflation is at its 40-year high and an early 1990s-style recession is looming. The UK has a tight labor market, like the US, and an energy shock, like the eurozone. Finding an escape route could be further complicated by the unorthodox economic policies of Liz Truss, the candidate who could become the next prime minister.
Tax cuts should be an important feature of Truss’s premiership. This, as its rival Rishi Sunak argues, could fuel inflation and put upward pressure on interest rates. Nigel Lawson, Chancellor of the Thatcher government, draws parallels with the 1972 “dash for growth” budget, followed by years of high inflation.
In that era, gold outperformed. Its value has increased nearly seven times in real terms. Commodities like oil and wheat also did well. The poor performance of equities showed that they were a weak hedge against inflation.
Market analysis dating back to 1900 tells a similar story. In times of high inflation, according to a Credit Suisse study, the real return on equities was -10%. The bonds meanwhile produced a negative return of 24.7%. Separately, the study showed that during times when interest rates were rising, investors in UK equities would have been better off staying in cash, which returned 0.6% more per year.
However, some sectors may do well. Although banks may be hit by bad loans as the recession deepens, higher interest rates are adding to their net interest margins. Truss is an opponent of the fluke, making it unlikely that she would copy the taxes of the 1981 one-time bank levy imposed by her model Margaret Thatcher.
Truss is openly pro-business. Its policy of canceling corporate tax hikes would benefit investors in companies that are doing well. But protecting corporate profits would be an unpopular policy when voters want help with their bills. As the economy goes into recession, it may find it difficult to stick to his policies. No plan survives intact contact with reality.
Lex’s team is interested in learning more from readers. Please tell us what the economic consequences of a Liz Truss premiership would be in the comments section below.