Investors, not impressed by Kwarteng’s first ideas from his “new era focused on growth”
UK government’s tax giveaway announced on Friday by Kwasi Kwarteng, Britain’s new chancellor of the exchequer, did too little to impress the investors and economists alike.
The cost of money that government must borrow soared, while the pound lost its grip.
These reactions of the market are the opposite of what Prime Minister Liz Truss expected at the beginning of “a new era, focused on growth”, as Kwarteng proclaimed.
In advance of Friday’s announcement, sterling fell to $1.138, down from $1.22 last month and $1.40 last year.
Three weeks ago, when Truss won her party’s leadership, the yield on 10-year UK government bond was below 3%. Now its 4.2%.
According to the Institute for Fiscal Studies, Britain’s mounting debt could become unsustainable, if the government presses ahead with the tax cuts.
The bill for tax giveaway is to reach 45 billion pounds by the tax year ending April 2027, and new fiscal rules were not yet announced by Kwarteng, who hinted to similar moves in the future.
The Treasury said though Kwarteng would set out his medium-term fiscal plan later that month.
The government wants lower income and corporate taxes, also reforms to the planning system, business regulations and immigration.
But instead of delivering a short-term boost to growth, these moves could spark a run on the pound and miss the Treasury’s existing budget targets.
This could become a fact sooner since 60 billion pounds will cost the government to cap energy bills for households and businesses for six months.
Kwarteng acknowledges the sum depends on wholesale energy prices.
Energy experts like Gene Frieda, a strategist at fund management giant Pimco, point out that there are downsides to be considered.
She says that the price cap effectively hitches UK fiscal policy to the cost of gas. In the end taxpayers are also shouldering the exchange rate risk since a chunk of the gas is imported.
Of course, the Bank of England is expected to further tighten the monetary policy, with effect on consumer demand, and interest payments on mortgages and loans.
Investors are expecting that official rates will be 4.75% or higher by early February 2023, that is according to market prices compiled by Refinitiv, that implied a 100% likelihood that this happens.
Last week, central bank raised rates by half a percentage point to 2.25% saying it would analyze the effects of the government’s plans at its next meeting in November.
Giving the market fallout, Kwarteng has the classic option of reducing spending.
Other options are abandoning some tax cuts, or breaking the government’s promise not to impose a windfall tax on utilities.
In the end, Kwarteng’s promise of growth may prove harder than expected to fulfil.