UK tax-cutting gamble sends the pound plunging to new 37-year low

A huge gamble by the UK government aimed at rescuing the economy from recession and boosting long-term growth sent the pound plunging on Friday.

Announcing the biggest tax cuts in 50 years at the same time as boosting spending, Finance Minister Kwasi Kwarteng said the government needed a “new approach for a new era, focused on growth.”

The sweeping tax cuts, which include slashing the top rate of income tax to 40% from 45%, reductions in duties paid on house purchases, and the cancellation of a planned hike in business taxes, would wipe £45 billion ($50 billion) off government revenues over the next five years, the UK Treasury said.

Paul Johnson, director of the Institute for Fiscal Studies, an independent think tank, called the government’s plans “extraordinary.”

“It’s half a century since we’ve seen tax cuts announced on this scale,” he said in a tweet.

The pound sank almost 2% to $1.10 on Friday after Kwarteng’s announcement to its lowest level since 1985. British government bonds also sold off sharply. The yield on the benchmark 10-year bond, which moves opposite prices, is nearing 3.66%. It started the year below 1%.

At the same time as cutting taxes, Kwarteng said the government will press ahead with subsidizing energy bills for millions of households and businesses at a cost of £60 billion ($67 billion) just for the next six months, funded by borrowing rather than by taxing the windfall profits of oil and gas companies.

The measures come a day after the Bank of England warned that the country was already likely in a recession. It jacked up interest rates for a seventh time since December last year in a bid to tame 10% inflation that is causing a deep cost-of-living crisis for millions of people.

‘Unfunded giveaways’

News of the heavy additional government borrowing rattled investors 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 foreign exchange research at Deutsche Bank, said in a research note on Friday that the United Kingdom’s “very large, unfunded tax cuts and other fiscal giveaways” was adding to worries about the country’s economy.

“The UK’s immediate challenge is not low growth,” Saravelos said. “The large fiscal spend just announced may boost growth a little in the short term. But the bigger question is this: who will pay for it?” he added.

A senior government minister, Simon Clarke, speaking earlier Friday denied suggestions that new Prime Minister Liz Truss was taking a huge gamble with the British economy.

“The evidence of the 1980s and the 1990s is that a dynamic low tax economy is what delivers the best growth rates — this isn’t a gamble, the weight of history and evidence is with us,” he told the BBC.

The hefty energy subsidies will mean inflation should peak at 11% next month, according to the Bank of England, rather than shooting even higher this winter. But investors are concerned that the additional government spending will keep inflation at an elevated level. And a falling pound only makes matters worse by raising the cost of imports.

The opposition Labour Party criticized the government’s plans to ramp up borrowing instead of increasing a tax on the windfall profits of energy companies.

“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 higher than it needs to be just as interest rates rise,” said Rachel Reeves, the opposition’s finance spokesperson.

Kwarteng also announced he would end a cap limiting bankers’ bonuses to double their annual salary that was introduced after the global financial crisis to deter excessive risk-taking. He said he wanted to encourage global banks to invest in the United Kingdom.

Labour’s Reeves said the plan would “reward the wealthy” and represented a return to the “trickle down [economics] of the past.”

Mark Thompson, Julia Horowitz and Amy Cassidy contributed reporting.

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