Summary
- Kwarteng cuts top rate of income tax in rush for growth
- Significant rise in UK government debt issuance planned
- Gilts suffer largest drop in decades
- Pound slumps 3% to new 37-year low against dollar
Britain’s new finance minister Kwasi Kwarteng delivered historic Britain tax cuts and significant increases in borrowing on Friday in an economic agenda that crushed financial markets, sending British government bonds and the pound into freefall.
Kwarteng threw out the country’s top rate of income tax, called off a scheduled rise in corporate taxes, and for the first time placed a price tag on the spending plans of Prime Minister Liz Truss, who plans on doubling Britain’s rate of economic growth.
Investors discarded short-dated British government bonds as fast as they could, with the cost of borrowing over five years witnessing its largest one-day increase since 1991, while the sterling plunged more than 3% versus the dollar to levels last seen 37 years ago.
Notably, investors and economists said Truss’s government, in authority for less than three weeks, was eroding financial credibility after it began tax cuts and big spending plans just a day after the Bank of England raised interest rates to curb soaring inflation.
U.S. bank Citi cautioned that the pound could drop to parity with the dollar. “Something has to give, and that something will eventually be a much lower exchange rate,” analyst Vasileios Gkionakis said in a research note. Deutsche Bank said the central bank needed to deliver a huge unscheduled interest rate rise as early as next week to rebuild credibility and calm markets.
Kwarteng’s declaration marked a steep change in British financial policy, recalling the Thatcherite and Reaganomics doctrines of the 1980s that critics have dismissed as a return to “trickle down” economics.
Truss, appointed as prime minister earlier in September by a vote of the Conservative Party’s 170,000 members, has promised to prioritize and deregulate economic growth, even if it benefits the wealthy at a time when millions are straining to cover basic household bills.
Kwarteng said:
“That is how we will compete successfully with dynamic economies around the world. That is how we will turn the vicious cycle of stagnation into a virtuous cycle of growth.”
Speaking hours after he made his statement in parliament, Kwarteng refused to comment on the slump in the pound, saying he did not comment on market moves. He told reporters:
“I think it’s a very good day for the UK because we’ve got a great plan.”
Huge Gamble?
The so-called mini-budget is aimed at breaking the economy out of a period of double-digit inflation caused by rising energy prices and a 15-year run on stagnant real wage growth. Moves to subsidize energy bills will cost 60 billion pounds ($65.3 billion) just for the next six months, Kwarteng said – part of a vow to help households for two years.
Britain tax cuts- including a steady reduction in a property purchase tax – would cost an additional 45 billion pounds by 2026/27, he said, costs that could be retrieved by an increase in the annual economic growth of 1 percentage point over half a decade – a move many economists think unlikely.
Britain also will speed up moves to boost the City of London’s competitiveness as a global financial centre by abolishing the cap on banker bonuses ahead of an “ambitious deregulatory” package later this year.
In general, the plans will need an additional 72 billion pounds of government borrowing over the next six months only.
Caroline Le Jeune, head of tax at accountants Blick Rothenberg, stated:
“In 25 years of analyzing budgets this must be the most dramatic, risky, and unfounded mini-budget. Truss and her new government are taking a huge gamble.”
The opposition Labor Party said the plans were a “desperate gamble” by a government that had achieved lower investment, lower growth, and lower productivity.
“The only things that are going up are inflation, interest rates, and bankers’ bonuses,” said Labour’s finance spokeswoman Rachel Reeves.
A Bumpy Ride Ahead For Britain Tax Cuts
The Institute for Fiscal Studies said the tax cuts were the greatest since the budget of 1972 – which is widely generally remembered as resulting in disaster due to its inflationary effect.
On Thursday last week the BoE said Truss’s energy price cap would curb inflation in the short term but that government stimulus was expected to deepen inflation pressures further out, at a time when it is combating inflation almost at a four-decade high.
Trevor Greetham, head of multi-asset at Royal London Asset Management said:
“We are likely to see a policy tug of war reminiscent of the stop-go 1970s. Investors should be prepared for a bumpy ride.”
Financial markets stepped up their expectations for interest rates to reach a peak of more than 5% midway through 2023. Despite the vast spending and tax measures, the government did not post borrowing and growth forecasts from the Office for Budget Responsibility (OBR) government watchdog.
Buy Crypto NowThe National Institute of Economic and Social Research (NIESR) said the budget deficit seemed ready to jump to 8% of gross domestic product during the current financial year. The OBR predicted in March that Britain would have a budget deficit of 3.9 percent of GDP. Kwarteng said the OBR would post its full forecasts later in the year.
“Fiscal responsibility is essential for economic confidence, and it is a path we remain committed to,” he said.
($1 = 0.8872 pounds)
($1 = 0.9195 pounds)
