Pound sinks in reaction to huge UK stimulus

Pound sinks in reaction to huge UK stimulus

Opposition decries 'casino economics' but government says tax cuts will spur economy

Chancellor of the Exchequer Kwasi Kwarteng outlines the British government’s Growth Plan in the House of Commons in London on Friday. (UK Parliament/Jessica Taylor/Handout Photo via Reuters)
Chancellor of the Exchequer Kwasi Kwarteng outlines the British government’s Growth Plan in the House of Commons in London on Friday. (UK Parliament/Jessica Taylor/Handout Photo via Reuters)

LONDON: The British pound plunged to a 37-year low and stocks sank after the government delivered the most sweeping tax cuts since 1972, as economists warned that the ambitious plan was unsustainable at a time when inflation is rampant.

The plan, which slashes levies on rich households and companies in a bid to boost economic growth, triggered a massive market selloff of the currency and bonds early Friday. The pound slipped below $1.10 for the first time since 1985, sliding 2% in addition to declines earlier in the week. The all-time low for sterling, also set in 1985, was $1.0520.

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 a spiralling government debt burden. 

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. He warned the UK currency is “in danger” and suggested markets were treating it like a developing economy. 

The package was even 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 pledg to “reduce debt as a percentage of GDP over the medium term”.

The Conservative administration hopes its programme of lower taxes and deregulation will turbocharge 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 apologise 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 prioritise growth,” he told Parliament in London. “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.

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 spiralling inflation and a recession. 

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

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

Other 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 spiralling 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.

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