Britain is pushing investors to flee with historic tax and borrowing cuts

  • Kwarteng cuts top income tax rate in a rush of growth
  • Huge increase in planned British government bond issuance
  • Thrombosis suffers its biggest recession in decades
  • The pound fell 3% to a 37-year low against the dollar

LONDON (Reuters) – Britain’s new chancellor Kwasi Quarting unleashed historic tax cuts and massive borrowing increases on Friday in an economic agenda that flooded financial markets as British government bonds and the pound slumped.

Kwarteng scrapped the country’s highest income tax rate, scrapped a planned increase in corporate tax and for the first time put a price on the spending plans of Prime Minister Liz Truss, who wants to double Britain’s rate of economic growth.

Investors dumped Britain’s short-term government bonds as quickly as they could, as the five-year cost of borrowing saw its biggest one-day rise since 1991, while sterling plunged more than 3% against the dollar to levels last seen 37 years ago.

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Economists and investors said markets are losing confidence in Truss’ ability to fight rising inflation after her government set out massive tax cuts and spending plans just a day after the Bank of England raised interest rates by half a percentage point. Read more

US bank Citi warned that the pound could par with the dollar. “Something has to be given and that is something that will ultimately be a much lower exchange rate,” Citi analyst Vasilios Gekionakis said in a research note.

Quarting’s announcement marked a change in British economic policy, returning to the 1980s Thatcher and Reaganomics doctrines that critics derided as a return to “flow-down” theory.

Truss, who was elected prime minister earlier this month by a vote of 170,000 Conservative Party members, has vowed to cut regulations and pursue inclusive economic growth even if it is in the interest of the wealthy at a time when millions are struggling to cover basic family bills.

“This is how we will successfully compete with dynamic economies around the world,” Kwarteng said. “This is how we are going to turn the vicious cycle of stagnation into a virtuous cycle of growth.”

In an interview hours after he made his statement in Parliament, Kwarteng declined to comment on the drop in sterling, saying he had not commented on market movements.

A huge gamble?

The so-called mini-budget is designed to pull the economy out of a period of double-digit inflation driven by high energy prices and stagnant real wage growth for 15 years.

Quarting said the moves to support energy bills would cost just £60 billion for the next six months – part of a two-year pledge to support households.

He said the tax cuts – including an immediate reduction in the property purchase tax – would cost another 45 billion pounds by 2026/27, costs that could be recovered by increasing annual economic growth by one percentage point over five years – a remarkable achievement. Most economists think it’s unlikely.

Britain will also speed up moves to boost London’s competitiveness as a global financial center by scrapping maximum bonuses for bankers ahead of an “ambitious deregulation” package later in the year. Read more

“In 25 years of analyzing budgets, this mini-budget has got to be the most dramatic, dangerous and unfounded,” said Caroline Le Jun, chief tax officer at Accountants Blake Rothenberg.

Truss and her new government are embarking on a huge adventure.

The opposition Labor Party said the plans were a “desperate gamble” by a government running out of ideas after 12 years in power. Read more

“Less growth, less investment, less productivity. Today we are learning that we have the lowest consumer confidence since records began. The only things that are going up are inflation, interest rates and banker bonuses,” said Labor finance spokeswoman Rachel Reeves. Read more

bumpy

The Institute for Fiscal Studies said the tax cuts were the largest since the 1972 budget — which is widely reported to have ended in disaster due to its inflationary impact.

The Bank of England said Thursday that Truss’s energy price cap will curb inflation in the short term, but government stimulus is likely to increase inflation pressures, at a time when inflation is struggling near a 40-year high.

“We’re likely to see a tug of war reminiscent of the 1970s hiatus,” said Trevor Greetham, head of multiple assets at Royal London Asset Management. “Investors should be prepared for a bumpy ride.”

Financial markets have raised expectations that UK interest rates will peak over 5% in the middle of next year.

Despite aggressive tax and spending measures, the government has not published new growth and borrowing forecasts from the Office of Budget Responsibility (OBR), a government watchdog.

The National Institute for Economic and Social Research (NIESR) said the budget deficit looks set to rise to 8% of GDP during the current fiscal year.

The Balance Sheet Office forecast in March that Britain would have a budget deficit of 3.9% of GDP. Kwarteng said the balance sheet office will publish its full forecast later this year.

“Fiscal responsibility is essential to economic confidence, and it’s a path we remain committed to,” he said.

(dollar = 0.8872 pounds)

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Written by Andy Bruce and Kate Holton; Additional reporting by Kylie McClellan, Kate Holton, Paul Sandel, Sachin Ravikumar, Alistair Smoot, William James, James Davey, Andrew McCaskill, Farouk Soliman, Hu Jones and Elizabeth Piper; Editing by Catherine Evans and Toby Chopra

Our criteria: Thomson Reuters Trust Principles.

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