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UK’s Biggest Tax Cuts Since 1972 Trigger Crash in Pound, Bonds

·6 min read
UK’s Biggest Tax Cuts Since 1972 Trigger Crash in Pound, Bonds

(Bloomberg) --

Most Read from Bloomberg

Liz Truss’s new British government delivered the most sweeping tax cuts since 1972, slashing levies on rich households and companies in a bid to boost economic growth in a move that triggered a massive market selloff in UK assets.

Chancellor of the Exchequer Kwasi Kwarteng announced a series of tax cuts and regulatory reforms that will cost £161 billion over the next five years. That fanned concerns about inflation, already near a 40-year high, and about a spiraling government debt burden.

https://t.co/ltTy3MUtXY pic.twitter.com/8T8OaFANg2

— Bloomberg UK (@BloombergUK) September 23, 2022

The pound crashed below $1.11 for the first time since 1985, sliding 2% in addition to declines earlier in the week. Borrowing costs on five-year government bonds jumped the most for a single day on record as traders dumped UK assets.

“It is extremely unusual for a developed market currency to weaken at the same time as yields are rising sharply,” said George Saravelos, global head of foreign exchange research at Deutsche Bank AG. He warned the UK currency is “in danger” and suggested markets were treating it like a developing economy.

The package was more ambitious than expected, with a big giveaway for the UK’s wealthiest households and plans to tear up planning rules and reform financial regulations.

Kwarteng scrapped the 45% additional rate of income tax, paid by only the richest earners, leaving the top rate at 40%, and cut the basic rate from 20% to 19%. He paid only lip service to concerns about rising public debt, reiterating a pledge to “reduce debt as a percentage of GDP over the medium term.”

https://t.co/ltTy3MUtXY pic.twitter.com/KXHYsWhhle

— Bloomberg UK (@BloombergUK) September 23, 2022

The Conservative administration hopes its program of lower taxes and deregulation will turbo-charge the economy, staving off a recession that the Bank of England says has already begun and shaking the UK out of a decade of weak growth.

Business groups embraced the decision, while economists said the measures may quickly become unaffordable. Unions and the Labour opposition said the measures will benefit the rich and do little to help those on moderate incomes with a tightening cost-of-living squeeze.

The opposition Labour party branded it “casino economics” and others warned that the government’s fiscal credibility now depended on whether it can hit its growth target. Kwarteng rejected that criticism.

“For too long in this country, we have indulged in a fight over redistribution,” the chancellor said. “We won’t apologize for managing the economy in a way that increases prosperity and living standards. Our entire focus is on making Britain more globally competitive.”

He set a target of 2.5% trend growth, a level not seen since before the 2008 financial crisis.

“We promised to prioritize growth,” he told Parliament in London on Friday. “We promised a new approach for a new era.”

The Treasury responded to concerns about high levels of borrowing needed to pay for his giveaway by promising new fiscal rules later this year that will ensure the debt falls as a share of national income “in the medium term.”

Kwarteng’s department also released figures suggesting stronger growth could lower borrowing by £40 billion. He said the numbers would be properly costed by the Office for Budget Responsibility.

What Bloomberg Economics Says ...

“The policies announced in Chancellor of the Exchequer Kwasi Kwarteng’s mini-budget will provide the economy with a sugar rush over the next year, but we highly doubt it’ll deliver the gear shift in growth that the government is banking on. That means it will lift inflation at a time when the Bank of England is trying to cool price pressure and, because the policy package is unfunded, put debt on an unsustainable path.”

--Dan Hanson, Bloomberg Economics. Click for the INSIGHT.

The measures will deliver a massive fiscal stimulus at a time when the Bank of England is struggling to rein in inflation, which at 9.9% is almost five times its target.

The plunge in gilt markets means that investors are now betting the central bank boosts its benchmark lending rate a full percentage point to 3.25% in November, which would be the sharpest increase since 1989. It’s a sign that traders believe that the extra borrowing will do little for growth but drive up prices even more quickly.

Paul Johnson, director of the Institute of Fiscal Studies, said the plan amounts to the biggest single giveaway by the Treasury since 1972, when Ted Heath was prime minister and Anthony Barber chancellor. Barber’s budget resulted in spiraling inflation and a recession.

“That budget is now known as the worst of modern times,” Johnson said on Twitter. “Genuinely, I hope this one works very much better.”

Tim Sarson, head of tax policy at KPMG, said the mini-budget signaled “a clear change of direction” and a “return to the economics of the 1980s.”

Martin Weale, who served at the BOE from 2010, said the government plans will “end in tears” and a run on the pound.

The chancellor’s plan included a pledge to liberalize regulations on planning and in the City of London’s financial district, ending a cap on bonus pay for bankers.

Additional eye-catching measures include a cut on stamp duty, which is charged on property purchases, removing 200,000 buyers out of the tax altogether. A planned 1.25% increase in payroll taxes this year was reversed. Businesses were given help, with the planned increase in corporation tax from 19% to 25% next year abandoned and investment allowances increased.

That came on top of support for households and businesses with spiraling energy costs. The Treasury said the emergency energy package, under which household bills will be frozen for two years, will cost £60 billion over the next six months.

Other measures announced were:

  • Steps to reduce planning restrictions for land use, “getting out of the way to get Britain building”

  • Creating 40 new “investment zones” with lower regulations for those who build businesses

  • Cancelling a planned increase in duties on alcohol

Truss and her allies say the program won’t spur inflation and that cutting taxes and bureaucracy will allow businesses to expand and draw more people into work, lifting tax revenue in the process.

“What we’ve seen today is a significant shift in economic policy in the UK, and I think it’s the right one,” Gerard Lyons, chief economic strategist at Netwealth Investments Ltd. and an adviser to Truss, said on Bloomberg Radio. “If the policy is right for economy, then also it should be right for the markets as well.”

Economists and former Bank of England officials attacked the plans even before Kwarteng appeared in the House of Commons on Friday. Danny Blanchflower, a policy maker during the global financial crisis more than a decade ago, said investors should short the pound.

Other critics include the Resolution Foundation, which points out the measure will widen inequality, handing more benefits to the richest people in society and costing those on lower incomes more.

(Updates with market reaction and comment from the top. A previous version of this story was corrected to restore a dropped name.)

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