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To revive the British economy and snatch it from the brink of recession, newly appointed Prime Minister Liz Truss’s new government proposed the sharpest tax cuts in 50 years and pledged to cap household utility bills.
In August, inflation in the U.K. ran at almost 9.9 percent. The Bank of England has raised its key interest rate steadily through most of this year, hiking it to 2.25 percent last week, the highest since 2008, and saying it may consider an additional emergency increase.
Truss’s sweeping plan would cut payroll and income taxes, freeze corporate taxes, reduce taxes on dividends, end a special income tax on earners making more than £150,000 a year, and scrap the cap on bankers’ annual bonuses, the biggest bundle of tax cuts since 1972.
On Sunday, 25 September, finance minister Kwasi Kwarteng announced that more tax cuts were coming.
His comment worsened the crisis: the pound fell to a record low of $1.0350 in Asian trading on Monday morning. It struggled back to $1.0855 and later slipped to $1.07.
Next month, the government is due to raise the limit it places on the amount utility companies can charge households for electricity and natural gas.
The new cap would send utility bills soaring by 80 percent, putting the average annual household energy cost above £3,500.
Instead, Truss has said she will cap household utility bills at £2,500 annually. The government will cover the difference, estimated to be anywhere from £90 billion to £200 billion, by selling bonds.
The government also will borrow an additional £72.4 billion to cover the near-term cost of the tax cuts and utility caps. Ultimately, the tax cuts alone could cost the government at least £150 billion, analysts estimate.
Government borrowing will top £190 billion this year, the third highest annual amount since World War Two, the private Institute for Fiscal Studies predicted.
New borrowing will make the looming recession shorter and shallower than it otherwise would be, according to the private National Institute for Economic and Social Research.
However, to keep inflation from running beyond control, the Bank of England would have to more than double its current interest rate of 2.25 percent to put it at 5 percent until at least 2025, the institute said.
The bank faces a “major challenge” in trying to tamp down inflation while the government stimulates the economy by injecting borrowed cash, Nicholas Ferres, chief investment officer at Vantage Point Asset Management, told CNBC.
“The Bank of England may even do an emergency policy meeting this week and hike rates, that wouldn’t surprise me if that happened,” he added.
Some analysts speculated that the bank will impose a full percentage point increase; others saw the bank jacking the rate by 1.75 percentage points before December.
News of the new tax cut lopped another 3 percent off the value of the pound, dropping it to its lowest value against the dollar since 1985, at $1.092 before falling below $1.04 early Monday.
At one point, the pound’s crash triggered a two-minute trading pause on the futures exchange.
Options markets now see a 50-percent chance of the pound reaching parity with the dollar this year, compared to 32-percent odds last Friday, 23 September.
The pound has lost about 20 percent of its value against the buck so far this year.
The pound’s newest plunge “is a consequence of an extremely risky budget by the new chancellor and a rather timid Bank of England that, so far, has only raised rates reluctantly despite all the clear pressures,” former U.K. finance minister James O’Neill said to CNBC.
The yield on government bonds jumped, with the 10-year bond’s return climbing to 4.14 percent on 26 September and topping that of its U.S. counterpart for the first time in years. The return on five-year bonds shot up almost a half-point to 4.54 percent.
Domestic stocks on London’s FTSE exchange were down about 1.7 percent on Monday, bringing the exchange’s loss to 25 percent this year.
“The U.K. has taken quite a dangerous gamble,” Fahad Jamal, chief investment officer at Kleinwort Hambros, told The Wall Street Journal.
Although interest rates are rising, the currency’s value is falling, he noted, a pattern usually only seen in developing countries facing economic chaos.
Some analysts commenting on the crisis referred to “the British peso.”
Complicating matters, the central bank is set to begin selling the bond portfolio it amassed during the COVID War. That means the bank and the government both will be pouring bonds into the market, likely driving down their prices and values.
Some economists predict the bank will now delay the sale indefinitely in an attempt to help the bond market stay upright.
Truss’s tax cut reminded some analysts of the U.K.’s 1972 budget, in which a Conservative government slashed taxes to win favor in the next election. The tax cuts sent inflation soaring and the Conservatives were booted from office.
The U.K. is expecting another election in 2024. Currently, Truss’s Conservative party is polling double digits behind the opposition Labour Party.
As the pound fell, so did the currencies of China, Japan, and South Korea.
TREND FORECAST: First the British politicians destroyed their economy with strict COVID War mandates that destroyed the lives and livelihoods of millions while inflation kept spiking.
Doubling down on stupidity, the new economic policies proposed by Truss are dumping steady streams of cheap money on the burning flames of inflation which hit a 40 year high of 9.9 percent.
Thus, the higher inflation rises and the deeper the sterling sinks, the more it will cost people to live. Also, since most commodities are dollar based and the U.K. is a big commodity importer, it will cost a lot more to buy a lot less.