FX.co ★ GBP surges as Liz Truss presents plans on energy

GBP/USD rallied yesterday after a 3-month slump, pushed upwards by Liz Truss' plans to tackle the energy crisis in the UK.

The good news for GBP

Liz Truss was elected prime minister yesterday after receiving the majority of the Conservative Party vote.

In the run-up to the vote, she promised to resolve the energy crisis currently plaguing the UK.

During her victory speech yesterday, she promised to present the details of her plan to fight high electricity prices by the end of this week.

Early on Tuesday, Bloomberg reported that Liz Truss planned to spend about £130 billion to support UK residents struggling with soaring energy bills.

Earlier, Ofgem announced that average household electric bills would increase by 80% to £3,548 in October.

However, Liz Truss plans to keep energy prices at the current price cap of £1,971. Energy suppliers will be obliged to charge households a reduced rate for their energy and the government will guarantee financing that will cover the difference with what they would have charged under the previous system.

Analysts believe that this plan could slow down inflation, which is expected to peak in October.

An outlook by The Capital Economics predicts that inflation in the UK will reach 10.5% and not 14.5% forecast earlier.

This would help the UK economy, which is currently on the verge of a recession, withstand the downturn.

As a result, GBP/USD gained 0.7% at the start of this week, bouncing back from its 2.5-year low towards 1.16.

The bad news for GBP

"We doubt Truss will be able to prevent a recession. But her policies could limit its depth and length. Our current forecasts envisage real GDP fall by around 1% from its peak to its trough over the course of a year," Paul Dales, chief UK economist at Capital Economics said.

Dales added that economic slowdown risk would remain high due to continuing interest rate hikes by the Bank of England aimed at fighting record high inflation.

Although headline inflation will be protected from another energy-induced shock, underlying inflationary pressures in the economy might be boosted as a result of Truss' plans.

Liz Truss pledged to decrease taxes "from day one" by using borrowed funds.

Cutting VAT is intended to boost the economy, but it could jeopardize it in the long run.

If tax cuts are delivered, it would lead to increased consumer activity, as households would find their financial outlook significantly improved. This in turn would drive up price growth even further.

Increased headline inflation would force the BoE to continue rate hikes, which would severely impact the UK economy.

In the near future, GBP's situation would likely remain unchanged despite the new PM being sworn into office.

Technical indicators suggest GBP/USD would continue to move south. The instrument remains in a bearish trend channel, despite Monday's upsurge, and would face additional resistance at $1.20.