Sterling tumbled against the dollar to below $1.09, hitting its lowest point since 1985, after British Chancellor Kwasi Kwarteng unveiled a debt-financed £45bn tax relief package. pound that triggered a historic rise in borrowing costs.
Kwarteng’s political and economic pledge includes the biggest set of tax cuts in 50 years, with the end of the 45p surcharge for the highest earners as well as a sharp reduction in tax on dividends.
But concerns over the amount of debt needed to fund the tax cuts in Kwarteng’s fiscal statement sparked a hectic 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 an underwater market,” former US Treasury Secretary Larry Summers told Bloomberg TV. “Britain will be remembered for running the worst macroeconomic policies of any major country for a long time.”
The Institute for Fiscal Studies predicts that public borrowing will top £190 billion this year, the third-highest peak since the Second World War.
In an interview with the Financial Times, Kwarteng promised to produce a medium-term fiscal plan “in the new year” as he seeks to reassure markets that he has a strategy to cut debt as a share of GDP.
But he insisted that the “big bet” would have been to stay on a high-tax, low-growth path. “The danger is in stifling growth. That’s the danger. The only way we deal with it is by growing the economy.”
Reacting to the financial turmoil that followed his statement, he said: “Markets move all the time. It’s very important to stay calm and focus on the long-term strategy.”
The new borrowing to fund the tax cuts and emergency energy subsidies will be more expensive for Britain, with two-year borrowing costs rising to 4 percent from 0.4 percent a year ago as investors sold off government bonds.
Kwarteng has staked the Conservative Party’s political fortunes on the bet that the radical tax cuts and deregulation will lift Britain’s sluggish growth rate to 2.5 per cent.
“This is a new approach to a new era focused on growth,” he told MPs to a chorus of Tory cheers and jeers from the Labor benches.
Unlike previous big tax cuts in the 1980s, Kwarteng will borrow tens of billions of pounds to finance his plans, boosting demand at a time when the Bank of England is to raise the interest rate to bring inflation under control.
Paul Johnson, director of the IFS, said: “The plan appears to be to borrow large sums at increasingly expensive interest rates, put national debt on an unsustainable path and hope we get better growth.”
The National Institute of Economic and Social Research said that because of the extra borrowing, a UK recession would now be shorter and shallower than feared. But to keep inflation under control, it said the BoE should raise interest rates to 5 percent and keep them there until at least 2024.
The basic rate of income tax will be cut from 20p in the pound to 19p next April and national insurance will be cut, as will tax on dividends. Stamp duty will be cut to help first-time buyers and a planned corporation tax rise will be scrapped.
The income tax cuts mean that someone earning £200,000 stands to make annual tax savings of almost £4,500 in 2023-24 compared to 2022-23. A worker on a salary of £20,000 will save £218.
The total cost of the tax cuts in 2026-27 will be almost £45bn. Kwarteng told MPs in a statement from the House of Commons that his aim was to turn “the vicious circle of stagnation into a virtuous circle of growth”.
The chancellor’s package combined tax cuts with a series of supply-side reforms, which he admitted could be unpopular in the short term; he insisted he would be “unashamed” of growth.
However, he admitted that the transformation of Britain’s growth prospects “would not happen overnight”.
Anticipating criticism that he was giving undue aid to the rich, Kwarteng reminded MPs that the government intervened to keep home and business energy bills down. He said the cost of the energy package for the first six months would be £60bn.
Quarterly confirmed he was scrapping the cap on bankers’ bonuses, a move meant to make the City of London more competitive but leaves the Conservatives open to Labour’s claims that it is still “the party of the rich”.
Rachel Reeves, the shadow chancellor, described the finance package as “one last roll of the dice” by the Tory government after “12 years of economic failure”. She warned that the government’s borrowing was too high, just as interest rates were rising.
Among other measures Kwarteng has announced, corporate tax rates will remain at 19 percent, but he will maintain the 8 percent levy on bank profits, which was due to be reduced next year.