Defiant Kwasi insists his plan will kickstart economy

Kwasi Kwarteng’s bold growth spurt could be blown off course by financial markets’ negative reaction to its tax cuts and the threat of an imminent global recession, experts warn.

The pound rose against the dollar yesterday after falling to record lows on Monday, when the Bank of England stepped in and said it would not hesitate to raise interest rates.

A weaker pound threatens to fuel inflation, now just below 10 percent, as it makes imports more expensive. But it is the rise in the cost of public debt that poses the greatest threat to the chancellor’s radical plans to end years of sclerotic growth, economists say.

Treasury bond yields – the interest paid on government IOUs – continue to hover near their 12-year high on fears that the Chancellor’s £45 billion in tax cuts to boost growth will will lead to a large increase in loans.

It led to an intervention by the International Monetary Fund last night, which said: ‘We are not recommending large and untargeted fiscal packages at this time.

Julian Jessop, an independent economist, said: ‘The rise in bond yields is the greater threat to the growth agenda than the fall in the pound, which is good for exporters, at least. Higher bond yields aren’t good for anyone, except maybe the banks.

‘The borrowing costs will be higher for the entire economy, including for mortgages and corporate debt, but also for the government.’

Some lenders have stopped offering new home loans due to increased market volatility.

But in a meeting with banks and other financial institutions yesterday, Kwarteng insisted that his loan-financed tax cut package would boost growth in the medium term.

“We are confident in our long-term strategy to boost economic growth through tax cuts and supply-side reforms,” ​​he said.

“We responded at short notice with an expansive fiscal stance on energy because we had to. With two exogenous shocks – Covid-19 and Ukraine – we had to intervene.

‘Our 70-year high tax burden was also unsustainable.

“I am confident that with our growth plan and the forthcoming medium-term budget plan, in close cooperation with the Bank, our approach will work.”

Despite efforts to calm markets, Bank of England governor Andrew Bailey remains under pressure to hold an emergency meeting of the monetary policy rate-setting committee less than a week after the cost of borrowing to 2.25 percent have been raised.

“The most important thing is that if you mention it, you have to take drastic measures,” said Professor Sir Charlie Bean, the Bank’s former deputy governor for monetary policy. “The lesson is that you go big and go fast.”

Markets predict that interest rates could reach 5 percent by the end of this year and 6 percent next year.

Economists recognize that Kwarteng’s tax cuts and energy bailout plan will shorten any downturn. “The combination of the energy tax and the reversal of planned tax increases will prevent a deep recession that would have blown public finances out of the water,” said Gerard Lyons of wealth adviser NetWealth, who is also an adviser to Prime Minister Liz Truss.

The chancellor thinks his measures to increase production will lead to an annual growth of 2.5 percent.

No one doubts that this goal is ambitious as the economy, hammered by Covid and the cost of living, stagnates.

He also faces boosting growth amid the global economic gloom. The World Bank recently warned that leading central banks risk sending the global economy into a “devastating” recession next year if they raise the cost of borrowing too much.

“Central banks are doing their best to raise interest rates as inflation rises to its highest level in nearly two generations, but they risk being too forceful,” economist Maurice Obstfeld warned.

Germany, Europe’s largest economy, “is heading for a winter recession,” says Munich-based research institute Ifo.

“A recession is looming in the eurozone as companies report that business conditions are deteriorating and price pressures are mounting due to rising energy costs,” said Chris Williamson of S&P Global Market Intelligence.

Even the US, the world’s largest economy, is vulnerable. More than half of economists recently said it could enter a recession in the next 12 months.

In the UK, there are fears that attempts by the Bank of England to tackle inflation by raising borrowing costs to 5% or more could plunge the country into a damaging recession. Bailey has been accused of ‘sleeping behind the wheel’ by not raising fares sooner and faster.

The risk now is that he will go too far the other way.

Either way, if the governor and chancellor fail to regain the confidence of the markets, borrowing costs are likely to rise. In the meantime, the priority is to restore calm – and not before time.

“Talking about ‘market meltdown’ and a ‘sterling crisis’ is an exaggeration,” Jessop said. “It may take more time to convince investors and the general public, but the most important thing is to get the economy in order. This is a good start, despite the negative headlines.’