UK’s tax cut pivot down to politics not economy, analysts say

Gilts and sterling not out of the woods after tax cut reversal, strategist says

LONDON — The UK government’s reversal in scrapping the top income tax rate is on political optics and will not calm market jitters over its economic plan, analysts told CNBC on Monday.

The tax cut, which Prime Minister Liz Truss had defended just hours earlier, would have eliminated a 45% rate paid on annual earnings over £150,000 ($166,770).

Paul Dales, UK chief economist at Capital Economics, said it would have a limited impact on revenue.

“Of the £44bn of net fiscal easing up to 2026/27 announced by the Chancellor in the mini-budget, the 45p tax cut accounted for just £2bn. So it’s more politics than economics,” he said via email.

This was reflected in the statement by Finance Minister Kwasi Kwarteng, who said in a statement that addressing the challenges facing our economy has become a “distraction from our overarching mission”; and Conservative MP Grant Shapps, who said it “shook people up in an unsustainable way”.

Also Read :  Chile's economy to slow sharply in 2022 and contract in 2023, OECD says

The UK Treasury previously confirmed that the tax cut would result in an average saving of £10,000 for 660,000 people.

Susannah Streeter, senior investment and market analyst at Hargreaves Lansdown, agreed.

“The reversal is only a small part of the equation in terms of the proposed tax cuts and has been made clearly to limit further policy impact,” she told CNBC, adding that markets are still factoring in a benchmark rate hike to at least 5 .5% next year.

“It is still likely that people on the lowest incomes will foot the bulk of the cost of the cuts, with the government refusing to rule out that benefits will be affected,” she said.

Rate hike expectations for the Bank of England, next scheduled for November 3rd, rose sharply following the September 23rd budget announcement, with the pound depreciating and the gilt market experiencing an historic sell-off.

Also Read :  After FTX, crypto investors need to rethink how to hold assets

“Most of the borrowing from the Sept. 23 mini-budget is still unfunded,” Jane Foley, senior FX strategist at Rabobank, told CNBC’s Squawk Box Europe.

It includes a package expected to be worth more than £100bn over the next two years to help businesses and households with energy bills.

Despite speculation that the government will explore what else it could cut, its decisions may not be easy or popular, Foley said. Meanwhile, the Bank of England’s emergency purchase program that has been supporting markets for the past week would eventually come to an end.

Kwarteng told the Conservative Party Conference on Monday that he wants to cut £18 billion in public services. He will give his keynote speech on Monday afternoon.

Also Read :  This week in Bidenomics: Housing pain

Foley said: “If the markets don’t believe in the credibility of government policies then gilts will still be very exposed and so is sterling. So not over the hill by a long shot, I would say.”

Sterling got a slight boost from the government’s tax cut and was trading 0.3% higher against the dollar at $1.12 as of 11:40 am London time on Monday. Gilt yields were lower, with the 10-year yield falling 2 basis points to 4.068%; still at levels last seen during the 2008 financial crisis.

Capital Economics’ Dales added: “The government is backtracking on its mini-budget in many ways.

“This suggests that fiscal policy may not be as expansionary as we all thought, although the legacy of the mini-budget still appears to be higher interest rates.”