The UK Chancellor Kwasi Kwarteng unveiled the biggest range of tax cuts in 50 years, including a reduction of the highest rate of income tax from 45% to 40%.
This unfunded £45 billion package of tax reductions, to be paid for by increased borrowing, sparked huge market fears over the direction of the UK economy.
During the current financial year borrowing is expected to jump up by £72 billion if this plan is implemented, which alongside the falling Pound, may increase inflationary pressures.
Three days after the announcement of what was described as a “mini budget”, the GBP/USD currency pair fell as low as $1.0350 as the sterling sell-off accelerated, before it steadied at $1.08, then later fell below $1.0600.
Bank of England Intervenes
The Bank of England on 28th September announced a surprise intervention by buying long term debt in the government bond markets, to try to create more financial stability in the markets.
This comes after the Bank said that it was prepared to ramp up interest rates, to halt the destruction of the value of the Pound.
Huw Pill, its chief economist was speaking at an International Monetary Policy Forum and revealed that a “significant monetary policy response” to protect Sterling would be delivered.
He also said that there had been significant market consequences after the tax cuts decision was made.
The recent 0.50% interest rate rise is the seventh consecutive monthly increase, and it is highly likely that trend will continue, even though rates are already the highest they have been for 14 years.
Mortgage lenders have decided to take drastic action by withdrawing some offers from the market, due the uncertainties over just how high that interest rates will go.
Prime Minister Liz Truss, only weeks into her new job, has certainly raised eyebrows with her shock and awe ideological approach to the UK economy, and the latest developments are reminiscent of the eighties style supply-side economics view supported by Margaret Thatcher.
Yet the new plans of injecting the economy with fresh demand appears to be at odds with the Bank of England, and other major central banks across the world, as raising rates is designed to calm demand and curb inflation.
City, Agency Fears Over Mini-Budget
The City of London is thought to be increasingly concerned over the new tax cut plans, which it believes could hamper rather than help growth.
It is feared that interest rates might climb as high as 6% next year, and the extra risk associated with the UK might result in companies borrowing at a premium.
This would be a scenario that would choke off growth, as businesses would be put off expanding and creating more jobs.
The IMF have warned that the budget tax cut plan could lead to greater price pressures due to borrowing, and further inequalities in the UK.
It also called for the UK government to reconsider its course ahead of the publishing of a fiscal plan on 23 November.
Usually, the IMF would make such interventionist statement towards a developing economy, as opposed to an established member of the G7.
Rating agency Moody’s has also been critical of the UK government, and said: “A sustained confidence shock, arising from market concerns over the credibility of the government’s fiscal strategy that resulted in structurally higher funding costs, could more permanently weaken the UK’s debt affordability.”
The Pound has depreciated again following the Bank of England’s bond announcement, falling by 1.28% against the Dollar, with £1 now buying $1.0590 as the start of trading in New York approached on 28th September.