Britain’s new government made a broad range of tax cuts official, hoping that it had discovered a way to spur economic growth despite high inflation. However, the market’s verdict was immediate and unfavourable: British stocks and bonds saw a rapid decline in value, and the pound hit lows against the dollar not seen since 1985.
Since the plans will require significant increases in government borrowing, there is a greater likelihood that the Bank of England will need to hike interest rates even higher to combat inflation. These tax cuts and the previously announced expenditure plans to protect people and companies from the rising cost of energy will now cost even more as a result of this.
The FTSE 100, Britain’s leading stock index, dropped 2% following the statement by Kwasi Kwarteng, the newly appointed chancellor of the Exchequer. But the pound and British government bond market movements drew the most attention.
Bond yields, which is the gauge of borrowing costs, soared, which will result in much higher interest rates for the government on any new debt it issues. The benchmark yield on 10-year government bonds increased to its highest level since 2011. In a market where daily movements on the chart are generally measured in hundredths of a point, the yield on the five-year bond increased by almost half a percentage point, to 4.05 percent.
“It’s fair to say that the gilt market hated today’s mini-budget. In what has already been a weak period for government bonds thanks to global inflation and central bank rate hikes, the U.K. has stood out as an underperformer,” Jim Leaviss, a bond investor stated in his analysis of the situation.
Additionally, the pound dropped to $1.09 on Friday, falling 2% versus the euro and more than 3% against the dollar. In relation to the dollar, the pound has decreased by more than 19% this year.
“Concerns over the U.K.’s fiscal position combined with its recessionary outlook and extremely high level of inflation leave the pound extremely vulnerable,” analysts at Rabobank explained in their statement commenting on the situation.
Delivering his speech to a crowded Parliament, Mr Kwarteng explained the government’s strategy, pledging to speed up economic growth through a combination of tax cuts and deregulation reminiscent of the 1980s under Prime Minister Margaret Thatcher. However, the government is preparing to spend £60 billion over the next six months to subsidise energy costs for individuals and businesses, the first part of a vast plan to freeze the cost of gas and electricity for consumers. This is why there is a focus on reducing taxes for firms and workers.
“The markets react as they will,” Mr Kwarteng said in the House of Commons on Friday. “But the growth plan will very soon show we are on the right course and we are steering us to a more prosperous future.”
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