Tuesday, October 4, 2022
Home BUSINESS British Pound Sinks as Markets React to UK Government Tax Cuts

British Pound Sinks as Markets React to UK Government Tax Cuts

Britain’s new government announced a sweeping series of tax cuts on Friday, betting it had found a path to economic growth despite high inflation.

But the market verdict was swift and negative: the value of shares, bonds and the British pound sank to the lowest level against the dollar since 1985.

The plans will require large increases in government borrowing and have raised expectations that the Bank of England will need to raise interest rates even more aggressively to stem inflation. This will further increase the cost of these previously announced tax cuts and spending plans to protect homes and businesses from rising energy costs.

Following the announcement by new Chancellor of the Exchequer Kwasi Kwarteng, the FTSE 100, the UK’s benchmark stock index fell more than 2 percent.

But the most striking market movements were the British government bonds and the pound.

Bond yields, a measure of borrowing costs, soared higher, which will make the interest the government pays on the new debt it issues much more expensive. The benchmark 10-year government bond yield rose to the highest level since 2011. And the five-year bond yield rose more than half a percentage point to 4.15 percent, a big move in a market where fluctuations Journals are generally measured in hundredths of a point.

The pound also fell 1 percent against the euro on Friday and fell nearly 2 percent against the US dollar to just over $1.10. The British currency has lost more than 18 percent against the dollar this year.

“Concerns about the UK’s fiscal position, combined with its recessionary outlook and extremely high level of inflation, leave the pound extremely vulnerable,” Rabobank analysts wrote in a note.

Mr Kwarteng outlined the government’s plan in a statement to a packed Parliament, promising to accelerate economic growth with a mix of tax cuts and deregulation that echoed the 1980s under Prime Minister Margaret Thatcher. But the emphasis on lower taxes for businesses and workers comes as the government prepares to spend £60bn over the next six months to subsidize energy costs for homes and businesses, the first phase of an expansive plan to freeze the cost of gas and electricity for consumers

“Markets react as they will,” Kwarteng told the House of Commons on Friday. “But the growth plan will show very soon that we are on the right track and heading towards a more prosperous future.”

Investors already seemed concerned about Britain’s fiscal state before Kwarteng revealed details of the new government’s plan. Britain’s budget and balance of imports and exports make the country dependent on what a former central bank governor called “the kindness of strangers” to fund economic plans.

“Sterling is in danger,” warned Deutsche Bank analysts, who have been concerned for weeks about investors losing confidence in Britain and its unwillingness to finance its current account deficit. “We are concerned that investor confidence in the UK’s external sustainability is almost completely eroding. And the only thing that can prevent the pound from weakening is a very aggressive bull cycle from the Bank of England.”


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