What Historic UK Tax Cuts Mean For The Markets: ‘Material Increase In Risks’ – iShares MSCI United Kingdom ETF (ARCA:EWU)

That iShares MSCI United Kingdom ETF EMU fell 5.3% on Friday after investors were unfazed by an aggressive series of tax cuts announced by the new UK government.

What happened? On Friday the new British Prime Minister Liz Truss announced a bold new stimulus package that includes tax cuts and investment stimulus. The UK government plans to cancel a proposed increase in the corporate tax rate, reverse a recent increase in income tax and cut taxes on certain companies in designated investment zones.

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The new stimulus package comes after the Bank of England said on Thursday the UK economy is likely already in recession.

Why it matters: UK Treasury Secretary Kwasi Kwarteng said on Friday that the suite of economic measures is part of Britain’s renewed focus on growth, which includes a target for medium-term economic growth of 2.5%.

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Here is an overview of all possible changes:

  • The UK corporate tax rate will remain at 19% rather than increasing to 25%. The 19% rate is the lowest among the G-20 countries.
  • The recent 1.25% tax hike on social security contributions will be reversed.
  • The base rate of income tax will be reduced from 20p to 19p.
  • The top income tax rate for earners above $166,770 will be reduced from 45% to 40%.
  • Stamp duty, a tax paid on home purchases, will be reduced.
  • The UK will create investment zones that offer companies special tax incentives, liberalized planning rules and reduced regulatory barriers to encourage investment.
  • A planned tax increase on alcohol is cancelled.
  • A cap on banker bonuses will be abolished.
  • The UK will create a refund system for VAT paid by overseas visitors.

Following the news, the British pound fell to a 37-year low against the US dollar. Investors also sold UK government bonds as investors appear concerned about the massive size of the stimulus package and its implications for the current state of the UK economy.

On Friday, Bank of America economist Robert Wood said the UK’s new fiscal package represents the UK’s third major fiscal shock in the past 15 years and significantly increases risk for UK investors.

“In short, we believe today’s package represents a material increase in risk: to inflation, to the policy rate and to the currency,” Wood said.

Gasoline Gas Take: Even after Friday’s big sell-off, the EMU ETF is down just 21% year-to-date in 2022, slightly better than the 23% drop for the ETF SPDR S&P 500 ETF Trust SPY. However, the longer-term picture tells a very different story about the UK economy and the impact of the Brexit decision and its fallout. Over the past 10 years, the SPY ETF is up 150.7% overall, while the EMU ETF is down 26.3% over that time.

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