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Pound, FTSE, Gilts All Slump After Kwarteng's Mini Budget Backfires

Economy Sep 23, 2022 06:07AM ET
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By Geoffrey Smith 

Investing.com -- U.K. assets were in freefall across the board on Friday after financial markets reacted negatively to the new government’s plans to cut taxes aggressively in the hope of stimulating growth.

Analysts said the plans represented the biggest tax cutting package in 50 years, drawing uncomfortable parallels with the failed "Dash for Growth" plan under the government of Ted Heath in the early 1970s. 

The pound slumped over 1.2% against the dollar to a new 37-year low of $1.1079 and also lost over 0.5% against the euro to trade at $1.1389.

In the stock market, the FTSE 100 fell 1.6%, while the more U.K.-focused FTSE 250 midcap index fell a more modest 0.6%.

Government bond prices also plummeted, pushing yields to their highest levels in years across the whole of the yield curve, as traders priced in the prospect of much heavier borrowing to fund a budget deficit that is set to widen sharply as a result of tax cuts worth 45 billion pounds and energy subsidies that will cost around 60 billion pounds over the next six months alone.

The benchmark 10-Year Gilt yield, a rough proxy for medium-term inflation expectations, soared another 30 basis points to a new 11-year high of 3.80%. It’s risen over 1.5 percentage points since Liz Truss emerged as the favorite to win the Conservative Party leadership contest. Truss took over as Prime Minister at the start of September.

The more interest-rate-sensitive 2-Year Gilt yield, meanwhile, rose even more, almost hitting a 14-year high of 4% before retracing to trade at 3.88% by 06:00 ET (10:00 GMT).

Chancellor of the Exchequer Kwasi Kwarteng had earlier announced that previous increases in corporate income tax and national insurance contributions, announced by Boris Johneon's government, would be cancelled. In addition, he abolished the top 45% rate of personal income tax, effectively bringing down the top rate to 40%. There were also cuts in stamp duty on home purchases and the announcement of plans for investment zones with various tax privileges for businesses.

"This truly is an entirely new economic policy," said Paul Johnson of the Institute for Fiscal Studies, who called the package the "biggest tax cutting event since 1972." 

Kallum Pickering, U.K. economist with Berenerg Bank, said in a note to clients that "the broad strokes of the government's 'Growth Plan' look positive" but warned that government borrowing would likely end up considerably higher than Kwarteng had indicated. Pickering was also critical of the government's setting of a 2.5% annual growth target, noting that this was well above the country's medium-term potential growth rate, which has suffered due to Brexit. 

"Even the best designed pro-growth tax and regulatory reforms would struggle to add 0.8 percentage points to U.K. trend growth," he argued. As such, he argued, the government has built in the risk that it will over-stimulate the economy to meet an "excessive growth target."

 

 

Pound, FTSE, Gilts All Slump After Kwarteng's Mini Budget Backfires
 

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Comments (2)
Brad Albright
Brad Albright Sep 23, 2022 7:38AM ET
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One would hope that an article titled Kwarteng's Mini Budget Backfires might have some mention of Kwarteng's mini budget backfiring. Lame.
Brad Albright
Brad Albright Sep 23, 2022 7:38AM ET
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When professionals update an article, they usually add a note notifying readers.
Graham Kinnear
Graham Kinnear Sep 23, 2022 7:25AM ET
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Things need to be put into perspective. The Dollar is rising against about every currency you can think of. with few countries not increasing interest rates as a result of rampant inflation. The very thing central banks told us was transitory.
 
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