Britain bets all on historic tax cuts and borrowing, investors take fright

LONDON, September 23 (Reuters) – Britain’s new Finance Minister Kwasi Kwarteng on Friday unleashed historic tax cuts and a huge increase in borrowing in an economic agenda that rocked financial markets, with sterling and UK government bonds in free fall.

Kwarteng has scrapped the country’s top tax rate, scrapped a proposed corporate tax hike and, for the first time, put a price tag on Prime Minister Liz Truss’ spending plans to double Britain’s economic growth.

Investors shed short-dated UK government bonds as quickly as possible, with the cost of borrowing over 5 years seeing its biggest one-day rise since 1991, when the UK cut its FY debt issuance plans by £72.4 billion to 234, 1 billion pounds raised billion pounds ($259 billion).

The pound slipped below $1.11 for the first time in 37 years.

Kwarteng’s announcement marked a crucial shift in British economic policy, continuing the tenets of the Thatcher and Reaganomists of the 1980s, derided by critics as a return to trickle-down theory.

Truss, who was elected prime minister by a vote of the 170,000 Conservative Party members earlier this month, has vowed to cut regulations and seek broader economic growth, even if it favors the wealthy at a time when millions are struggling to find the to cover basic household bills.

“In this way, we will successfully compete with dynamic economies around the world,” said Kwarteng. “This is how we transform the vicious circle of stagnation into a virtuoso cycle of growth.”

The so-called mini-budget aims to pull the economy out of a period of double-digit inflation fueled by rising energy prices and 15 years of stagnant real wage growth.

Steps to subsidize energy bills will cost £60billion over the next six months alone, said Kwarteng – part of a pledge to support households for two years.

Tax cuts – including an immediate land transfer tax cut – would cost a further £45bn by 2026/27, he said, a cost that could be recouped by a 1pp increase in annual economic growth over five years – a feat most economists believe for unlikely.

The UK will also accelerate steps to boost the City of London’s competitiveness as a global financial hub by lifting the cap on bankers’ bonuses ahead of an “ambitious deregulation package” later in the year. Continue reading

“In 25 years of budget analysis, this has to be the most dramatic, riskiest and unfounded mini-budget,” said Caroline Le Jeune, head of taxes at auditing firm Blick Rothenberg.

“Truss and her new administration are taking a big risk.”

Financial markets raised their expectations that UK interest rates would peak in excess of 5% in the middle of next year.

HISTORY REPEATED ITSELF?

The market backdrop could hardly be more hostile for Kwarteng as the pound has underperformed against the dollar almost every other major currency.

Much of the decline reflects the Federal Reserve’s rapid rate hikes to tame inflation — which has sent markets reeling — but some investors are concerned about Truss’ willingness to borrow big to fund growth.

A Reuters poll this week found that 55% of international banks and business advisory firms surveyed believed UK assets were at high risk of a severe loss of confidence. Continue reading

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

“Lower growth, lower investment, lower productivity. And today we learn that we have the lowest consumer confidence on record. The only things going up are inflation, interest rates and banker bonuses,” said Rachel Reeves, Labor finance spokesman. Continue reading

The Institute for Fiscal Studies said the tax cuts were the largest since the 1972 budget, which ended in disaster because of its inflationary impact.

On Thursday, the BoE said Truss’ energy price cap would limit inflation in the short term, but this government stimulus is likely to add further inflationary pressures at a time when it is battling inflation near a 40-year high.

“We’re likely to see a political tug-of-war reminiscent of the stop-go era of the 1970s. Investors should brace themselves for a bumpy ride,” said Trevor Greetham, Head of Multi-Asset at Royal London Asset Management.

Despite the extensive tax and spending measures, the government did not release new growth and debt forecasts from the Office for Budget Responsibility (OBR), a state watchdog.

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

The OBR forecast in March that the UK would run a budget deficit of 3.9% of GDP. Kwarteng said the OBR will release its full forecasts later this year.

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

($1 = 0.8872 pounds)

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

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