British chancellor of the exchequer Kwasi Kwarteng’s shock therapy fuelling anxiety

A lot of risk for very little reward seems to be main takeaway for investors and analysts from Kwasi Kwarteng’s Friday mini-budget. In what has been described as the largest tax-cutting exercise in the UK in 50 years, the new Conservative party chancellor of the exchequer unveiled a raft of measures benefiting high earners and plans for more cuts ahead and a review, aimed at moving towards a “more pro-growth tax system”.

But for many, the radical plan — copied directly from the Thatcher-Reagan playbook of the 1980s — is an exercise in economic shock therapy at a time when cortisol levels are already elevated. The reaction from money markets has been swift, brutal and dramatic. In a withering note published on Monday morning, as the pound sterling was beginning to fall out of the sky in early trading, analysts from Bank of America (BofA) summed up the prevailing sentiment. “UK asset prices,” wrote BofA’s Robert Wood and Kamal Sharma, “reacted to the fiscal package in a way more akin to an emerging market”, with UK gilts sent tumbling along with sterling.

Why? Largely because investors are increasingly concerned about the sustainability of the UK’s debt levels and its large current account deficit.

Boosting GDP

Pouring some cold water on Kwarteng’s trickle-down theories, the analysts have estimated that the whopping £45 billion (€50 billion) in additional tax cuts announced on Friday will boost UK GDP by a paltry 0.2 per cent, given that “higher earners have a low propensity to spend”, adding that “empirical evidence suggests tax cuts of this type have an inconclusive effect on potential growth”.

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On the monetary policy side, BofA now expects the Bank of England to further combat inflation by hiking rates by 75 basis points in November, December and February followed by smaller increases throughout the spring and summer of 2023 with no relief in sight for borrowers until the end of 2024. Some investors are factoring in a 200 basis point increase by November.

On the fiscal side, it seems likely if not inevitable that the Tory government will look to soothe angst-ridden investors by cutting spending. Politically, the market reaction to Kwarteng’s budget could play nicely into the hands of Liz Truss, who has expressed a willingness to make unpopular decisions in a bid to reboot the UK economy. Economically, however, the plans may raise more roadblocks in the short term, damaging the government’s credibility in international markets.