UK TAX CUTS TRIGGER UPHEAVAL IN FINANCIAL MARKETS

By Michael Jarvis, UK Correspondent

The UK’s economic outlook for at least the short to medium term has been left in a state of uncertainty following a series of major tax policy announcements by the new Conservative Party government.

In what was billed as a 'mini budget' presented by the current Chancellor of the Exchequer, Kwasi Kwarteng, on Friday September 23rd, the government outlined a series of far-reaching tax cuts which almost immediately sent the financial markets into turmoil and caused a rapid downward spiral of the British pound sterling.

In a surprise announcement on Wednesday, the Bank of England - the UK's central bank - said it was forced to take emergency action to prevent what it termed "material risk" to the UK's financial stability.

“To achieve this, the Bank will carry out temporary purchases of long-dated UK government bonds from 28 September. The purpose of these purchases will be to restore orderly market conditions. The purchases will be carried out on whatever scale is necessary to effect this outcome. The operation will be fully indemnified by HM Treasury.”

The corrective action by the Bank of England was the latest development in the fall-out triggered by tax slashes announced by the government. The Bank's urgent intervention on Wednesday came at the height of financial turbulence in what many analysts had started referring to as Black Wednesday.

At one point in trading following the government's mini budget, the pound was sliding towards one-to-one parity with the US currency, hitting a low £1.03 to the US dollar for the first time since the mid-1980s.

Among the key measures announced by the new Chancellor(Minister of Finance) Kwasi Kwarteng were; scrapping the 45 per cent top level of income tax for high earners and replacing it with a single higher rate band of 40 per cent. He also slashed the basic rate of income tax from 20 per cent to 19 per cent to take effect from April next year.

The government said the move is to stimulate the economy currently being battered by the combined challenges of a cost-of-living crisis and high inflation.

“As a Government, we will focus on growth – even where that means taking difficult decisions,” Mr Kwarteng said while presenting his mini budget titled Growth Plan 2022.

“None of this is going to happen overnight. But today we are publishing our Growth Plan that sets out a new approach for this new era, built around three central priorities: Reforming the supply-side of the economy, maintaining a responsible approach to public finances, and cutting taxes to boost growth.”

In an earlier statement in the wake of the uncertainty following the tax package, the Bank of England had said it was “monitoring developments in financial markets very closely in light of the significant repricing of financial assets.”

Crucially, it said the MPC(Monetary Policy Committee) will not hesitate to change interest rates by as much as needed to return inflation to the 2% target sustainably in the medium term, in line with its remit.”

The Bank had already raised the UK interest rates this year from a record low 0.1 per cent to a 14-year high of 2.25 per cent.

In a comment, its Chief Economist warned that the bank - which operates independently of the government - “cannot be indifferent” to the ongoing uncertainty.

Some analysts have interpreted that as a signal of a likely further hike in interest rates to stabilise the pound and prevent inflation from potentially spiralling out of control,

The International Monetary Fund(IMF) has also voiced its misgivings about the government’s tax-cutting economic strategy.

"Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy," an IMF spokesperson said.

A major concern in the fall-out from the government's tax-cutting spree is that the move will benefit high-earners more than those in the middle to lower income brackets.

Further anticipated corrective measures by the Bank of England are likely to include another hike in interest rates resulting particularly in higher mortgage rates and a wider impact on the property market. Some leading banks have started withdrawing some of their mortgage products.

But new Chancellor Kwasi Kwarteng is adamant that his approach will work and has urged the markets and others sceptical about his strategy to “give it time” to work.

Mr Kwarteng who served as Business Secretary in the Boris Johnson government, has been in the Chancellor’s job for less than a month.

He was appointed by Prime Minister Liz Truss on September 6th after her administration was installed in an internal Conservative Party vote to replace the Boris Johnson cabinet which had collapsed in a messy squabble over his integrity and leadership.