Sterling tumbled against the dollar to below $1.09, hitting its lowest point since 1985, after UK chancellor Kwasi Kwarteng unveiled a £45 billion (€50bn) debt financed tax-cutting package that sparked a historic increase in borrowing costs. Sterling also fell 2 per cent against the euro on Friday, trading around 89 pence.
Mr Kwarteng’s political and economic gamble includes the biggest set of tax cuts for 50 years, with the end of the 45 per cent additional rate for the highest earners as well as a sharp reduction in levies on dividends.
But concern about the amount of debt needed to finance the tax cuts in Mr Kwarteng’s fiscal statement triggered a frenetic day of trading that raised concerns about whether Britain’s new economic approach was sustainable.
“The UK is behaving a bit like an emerging market turning itself into a submerging market,” former US treasury secretary Larry Summers told Bloomberg TV. “Britain will be remembered for having pursued the worst macroeconomic policies of any major country in a long time.”
The Institute for Fiscal Studies forecast that public borrowing would top £190 billion this year, the third-highest peak since the second world war. Mr Kwarteng, in an interview with the Financial Times, vowed to produce a medium-term fiscal plan “in the new year”, as he seeks to reassure markets he has a strategy for cutting debt as a share of GDP. But he insisted the “big gamble” would have been to stay on a path of high taxes and low growth. “The danger is in choking growth. That’s the danger. The only way we deal with that is by growing the economy.”
Responding to the financial turmoil that followed his statement, he said: “Markets move all the time. It’s very important to keep calm and focus on the longer-term strategy.”
The new borrowing to finance the tax cuts and emergency energy subsidies will be more expensive for the UK, with the two-year cost of borrowing rising to 4 per cent from 0.4 per cent a year ago, as investors sold off government bonds.
Mr Kwarteng has staked the political fortunes of the Conservative party on the bet that the radical tax cuts and deregulation will raise Britain’s sluggish growth rate to 2.5 per cent.
“This is a new approach for a new era focused on growth,” he told MPs, to a chorus of Tory cheers and jeers from the Labour benches.
In contrast with previous big tax cuts in the 1980s, Mr Kwarteng will borrow tens of billions of pounds to fund his plans, adding to demand at a time when the Bank of England is raising interest rates to bring inflation under control.
Paul Johnson, director of the IFS, said: “The plan seems to be to borrow large sums at increasingly expensive rates, put government debt on an unsustainable rising path, and hope that we get better growth.”
The National Institute of Economic and Social Research said that, due to the additional borrowing, a UK recession would now be shorter and shallower than was feared. But to keep inflation under control, it said the Bank of England would have to raise interest rates to 5 per cent and keep them there until at least 2024.
Among other measures announced by Kwarteng, corporation tax rates will stay at 19 per cent, but he will maintain the 8 per cent charge on bank profits, which was due to be reduced next year. — Copyright The Financial Times Limited 2022