Britain scares away investors with historic tax cuts and borrowing

  • Kwarteng slashes top income tax rate amid growth momentum
  • Huge increase in UK government debt issuance expected
  • Gilts suffer biggest drop in decades
  • Pound drops 3% to new 37-year low against dollar

LONDON, Sept 23 (Reuters) – Britain’s new finance minister Kwasi Kwarteng on Friday announced historic tax cuts and huge increases in borrowing in an economic package that has floored financial markets, sending the pound sterling and UK government bonds plummeting.

Kwarteng scrapped the nation’s highest tax rate, reversed a planned corporate tax hike and, for the first time, put a price tag on Prime Minister Liz Truss’s spending plans, which want to double Britain’s economic growth rate.

Investors dumped short-dated UK government bonds as fast as they could, with the cost of five-year borrowing seeing its biggest one-day rise since 1991, while the pound fell more than 3% against the dollar to levels last seen 37 years ago. .

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Economists and investors said the Truss government, in power for less than three weeks, was losing financial credibility after announcing tax cuts and huge spending plans just a day after the Bank of England raised interest rates to contain the surge in inflation. Read more

US bank Citi has warned that the pound could fall to parity with the dollar. “Something has to give, and that something will end up being a much lower exchange rate,” analyst Vasileios Gkionakis said in a research note.

Deutsche Bank said the central bank needed to make a large unexpected hike in interest rates as early as next week to calm markets and restore credibility. Read more

Kwarteng’s announcement marked a sea change in British financial policy, reminiscent of the Thatcherite and Reaganomics doctrines of the 1980s that critics derided as a return to “trickle down” economics.

Truss, elected prime minister earlier this month by a vote of the Conservative Party’s 170,000 members, has pledged to deregulate and prioritize economic growth, even if it favors the wealthy at a time when millions of people struggle to cover basic household bills.

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

Speaking hours after making his statement in parliament, Kwarteng declined to comment on the pound’s fall, saying he had not commented on market movements. “I think it’s a very good day for the UK because we have a great plan,” he told reporters.

BIG BET?

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

Measures to subsidize energy bills will cost £60bn ($65.3bn) for the next six months alone, Kwarteng said – part of a pledge to support households for two years.

The tax cuts – including an immediate reduction in a property purchase tax – would cost an additional £45billion by 2026/27, he said, costs that could be recouped by increasing annual economic growth by 1 percentage point over five years – a feat most economists think unlikely.

Britain will also accelerate moves to boost the City of London’s competitiveness as a global financial center by scrapping the cap on bankers’ bonuses ahead of an “ambitious deregulation” package later this year. Read more

In total, the plans will require an additional £72bn of government borrowing over the next six months alone.

“In 25 years of analyzing budgets, this has to be the most dramatic, risky and unfounded mini-budget,” said Caroline Le Jeune, tax manager at accountants Blick Rothenberg. “Truss and his new government are taking a huge gamble.”

The opposition Labor Party said the plans were a “desperate gamble” by a government that had slashed growth, investment and productivity. Read more

“The only things going up are inflation, interest rates and bankers’ bonuses,” said Labour’s finance spokeswoman Rachel Reeves. Read more

bumpy

The Institute for Fiscal Studies said the tax cuts were the biggest since the 1972 budget – which is widely remembered as ending in disaster because of its inflationary effect.

On Thursday, the BoE said the Truss energy price cap would limit short-term inflation, but government stimulus measures were likely to add to inflationary pressures, at a time when it is battling higher inflation. close to a 40-year high.

“We are likely to see a tug-of-war policy reminiscent of the stop-go of the 1970s. Investors should be prepared for a bumpy ride,” said Trevor Greetham, head of multi-asset at Royal London Asset Management.

Financial markets have raised their expectations for interest rates to a peak of more than 5% by the middle of next year.

Despite the sweeping tax and spending measures, the government has not released growth and borrowing forecasts from the Office for Budget Responsibility (OBR) government watchdog.

The National Institute of Economic and Social Research (NIESR) said the budget deficit is expected to reach 8% of gross domestic product in the current fiscal year.

The OBR predicted in March that Britain would have a budget deficit of 3.9% of GDP. Kwarteng said the OBR would release its full forecast later this year.

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

($1 = 0.8872 pounds)

($1 = 0.9195 pounds)

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Written by Andy Bruce and Kate Holton; Additional reporting by Kylie MacLellan, Kate Holton, Paul Sandle, Sachin Ravikumar, Alistair Smout, William James, James Davey, Andrew MacAskill, Farouq Suleiman, Huw Jones and Elizabeth Piper; Editing by Catherine Evans, Toby Chopra, Kirsten Donovan

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