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When he rolled out the dazzling spending commitments at the start of the pandemic, Rishi Sunak promised to do whatever it takes.
Two and a half years after Russia’s war in Ukraine and a surge in global inflation, another Chancellor, Kwasi Kwarteng, has prompted another fiscal tidal wave.
But the way to pay for it is very different. And that has set alarm bells ringing in the markets, with both the pound and British bonds plummeting. One expert even said an urgent Bank of England raise could be needed next week to try and stop the defeat.
Kwarteng is betting big tax cuts and a bonfire of regulation will boost investment, boost growth and benefit the entire economy.
“That way we will successfully compete with dynamic economies around the world,” he said. ‘In this way we turn the vicious circle of stagnation into a vicious circle of growth.’
Sunak’s language was very different after his extensive intervention.
He spent £376 billion addressing the pandemic and its crippling effect on the UK economy. It was followed by the energy crisis and a £37 billion cost of living support package.
But Sunak was quick to warn that tough choices would have to be made to tackle the massive mountain of debt of more than £2 trillion. “We can’t spend money that we don’t have,” he said.
That led to a much-criticized raid on employees and employers in national insurance, and the highest tax burden in 70 years.
In addition to reversing that decision, Kwarteng has scrapped plans to raise the corporate tax rate, lift the stamp duty threshold and cut income taxes.
The austerity measures will mean a £44.8 billion annual blow to public finances by 2026-27, the biggest tax giveaway in half a century.
Added to this is a commitment to freeze energy bills for two years, at an estimated cost of £60 billion over the next six months alone. The total cost could reach around £100 billion, independent experts say. Kwarteng said it was “completely appropriate” and compared it to the action taken during the pandemic.
“It was a major intervention then and it is now,” he said.
Economists at HSBC said the package would “approach the scale of what was delivered during the pandemic” over the next two years. But “the background in terms of monetary conditions couldn’t be more different,” they noted.
In 2020, the interest rate was 0.1 percent. Today, with four decades of inflation, rates are rising, reaching 2.25 percent this week, the highest level since the financial crisis.
Already in the loop after 12 rounds with the overpowering dollar, the pound was positively inebriated after the Kwarteng announcement, plunging to a new 37-year low of less than $1.09.
British bonds – parcels of government debt – also sold out sharply. Five-year bond yields saw their largest single-day rise in 31 years. Higher returns translate into higher financing costs for the Treasury.
And much more will be needed. The Institute for Fiscal Studies predicts £190 billion, or 7.5 percent of GDP, in this fiscal year – surpassed only in the post-war period by the financial crisis and pandemic.
Director Paul Johnson said: “The first signs are that the markets, which will have to lend the money needed to close the gap in the government’s budget plans, are unimpressed.” George Saravelos, Deutsche Bank’s head of currency research, warned that “the pound is at risk,” quickly eroding investor confidence in the UK’s external sustainability.
Saving the pound from a weakening could mean sharp rate hikes are needed outside the regular cycle of monetary policy committee meetings. Saravelos said: ‘The required policy response is clear: a major rate hike by the Bank of England next week to regain credibility with the market.’
The Treasury estimates that Kwarteng’s austerity measures will boost the economy and ultimately bring in additional revenue, without estimating how much. It calculates that if 1 percent were added each year to projected GDP growth over the next five years, revenues would be £47 billion over five years – roughly equal to the blow of the planned tax cuts, despite skepticism that such a growth will happen.
There was a wide welcome from business groups. Kitty Ussher, of the Institute of Directors and former Labor Secretary, said: ‘This is a good news day for British business. In a time of low confidence and economic uncertainty, the emphasis on growth for companies of all sizes will be welcome.”
But she expressed concern that the independent Bureau of Fiscal Responsibility had not mastered the numbers.
“Without this, neither business nor Parliament will have any assurance that the scale of this intervention is affordable,” she said.
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