A huge bet by the British government aimed at rescuing the economy from recession and boosting long-term growth sent the pound plunging on Friday.
Finance Minister Kwasi Kwarteng announced the biggest tax cuts in 50 years while increasing spending, saying the government needed a “new approach for a new era, focused on growth.”
The sweeping tax cuts, which include a cut in top income tax to 40% from 45%, reductions in property tax and the cancellation of a planned rise in business tax, would wipe out 45 billion pounds ($50 billion) of government revenue over the next five years, the British Treasury said.
Paul Johnson, director of the Institute for Fiscal Studies, an independent think tank, called the government’s plans “extraordinary.”
“It’s been half a century since we’ve seen tax cuts announced on this scale,” he said in one tweet.
The pound sank nearly 2% to $1.10 on Friday after Kwarteng’s announcement to its lowest level since 1985. British government bonds also sold off sharply. The interest rate on the benchmark 10-year bond, which moves against rates, is approaching 3.66 per cent. It started the year below 1%.
While cutting taxes, Kwarteng said the government will continue to subsidize energy bills for millions of households and businesses at a cost of £60 billion ($67 billion) for the next six months alone, financed by borrowing instead of taxing oil and the unexpected profits of the gas companies.
The measures come a day after the Bank of England warned that the country was already likely to be in recession. It raised interest rates for the seventh time since last December in a bid to tame 10% inflation that is causing a deep cost-of-living crisis for millions of people.
The news of the heavy additional public borrowing rattled investors who were already concerned that the country is spending beyond its means. The IFS warned in a Wednesday report that government borrowing was on an “unsustainable path.”
George Saravelos, global head of currency analysis at Deutsche Bank, said in a research note on Friday that Britain’s “very large, unfunded tax breaks and other fiscal gifts” were raising concerns about the country’s economy.
“Britain’s immediate challenge is not low growth,” Saravelos said. “The big fiscal spending just announced may boost growth a bit in the short term. But the bigger question is this: Who’s going to pay for it?” he added.
A senior government minister, Simon Clarke, speaking earlier on Friday, dismissed suggestions that the new prime minister, Liz Truss, would take a huge gamble with the British economy.
“The evidence from the 1980s and 1990s is that a dynamic low-tax economy is what delivers the best growth rates – this is not a gamble, the weight of history and evidence is with us,” he told the BBC.
According to the Bank of England, the large energy subsidies will mean that inflation should peak at 11% next month instead of shooting even higher this winter. But investors are worried that the extra public spending will keep inflation at a high level. And a falling pound only makes matters worse by raising the cost of imports.
The opposition Labor party criticized the government’s plans to increase borrowing instead of increasing a tax on energy companies’ windfall profits.
“The oil and gas giants will be toasting the chancellor in the boardrooms as we speak, while working people are left to pick up the bill – borrowing more than they need to, just as interest rates rise,” said Rachel Reeves, the opposition chief financial officer. spokesperson.
Kwarteng also announced he would end a cap limiting bankers’ bonuses to double their annual salary, which was introduced after the global financial crisis to discourage excessive risk-taking. He said he wanted to encourage global banks to invest in the UK.
Labour’s Reeves said the plan would “reward the wealthy” and represented a return to “dive down” [economics] from the past.”
— Mark Thompson, Julia Horowitz and Amy Cassidy contributed reporting.