Kwasi Kwarteng’s bold race for growth could be derailed by the adverse financial market reaction to his tax cut budget and the threat of a looming global recession, experts have warned.
The pound rose against the dollar yesterday after falling to historic lows on Monday when the Bank of England intervened to say it would not hesitate to raise interest rates.
A weaker pound risks fueling inflation, currently at just under 10%, as it makes imports more expensive. But it is the rising cost of public debt that poses the biggest threat to the Chancellor’s sweeping plans to end years of sclerotic growth, economists say.
Gamble: The Chancellor believes his measures to boost production will lead to 2.5% annual growth.
Yields on gilts – the interest paid on government IOUs – continue to hover near their highest level in 12 years on fears that the Chancellor’s £45billion tax cuts to revive the growth does not lead to a sharp increase in borrowing.
This prompted an intervention from the International Monetary Fund last night, which said: ‘We do not recommend large, untargeted fiscal programs at this stage.’
Julian Jessop, an independent economist, said: “Rising bond yields are the bigger threat to the growth agenda than the falling pound, which is at least good for exporters.” Higher bond yields aren’t good for anyone, except maybe the banks.
“Borrowing costs will be higher across the economy, including for mortgages and corporate debt, as well as for government.”
Some lenders have stopped offering new home loans due to increased market volatility.
But in a meeting with banks and other financial institutions yesterday, Kwarteng insisted that its debt-financed tax cut program would boost medium-term growth.
“We are confident in our long-term strategy to drive economic growth through tax cuts and supply-side reform,” he said.
“We responded immediately with an expansionary fiscal policy on energy because we had to.” With two exogenous shocks – Covid-19 and Ukraine – we had to intervene.
“Our 70-year high tax burden was also unsustainable.
“I am convinced that with our growth plan and the next medium-term budget plan, in close collaboration with the Bank, our approach will work.”
Despite attempts to calm markets, Bank of England Governor Andrew Bailey remains under pressure to hold an emergency meeting of his monetary policy committee tasked with setting rates less than a week after raising the cost of borrowing at 2.25%.
“The bottom line is, if you call it, you need to take big steps,” said Professor Sir Charlie Bean, the Bank’s former deputy governor for monetary policy. “The lesson is you go big and you go fast.”
Markets expect interest rates to reach 5% by the end of the year and 6% next year.
Economists agree that tax cuts and the Kwarteng energy bailout will shorten any downturn. “The combination of the energy tax and the reversal of planned tax hikes will prevent a deep recession that would have blown public finances,” said Gerard Lyons, of wealth adviser NetWealth, who is also an adviser to the Premier Liz Truss.
The Chancellor estimates that his measures to boost production will lead to annual growth of 2.5%.
No one doubts that this objective is ambitious given that the economy, hammered by the Covid and the cost of living, is stagnating.
It is also faced with the revival of growth in a context of global economic sluggishness. The World Bank recently warned that major central banks risk sending the global economy into a “devastating” recession next year if they raise borrowing costs too much.
“Central banks are scrambling to raise interest rates as inflation hits the highest levels in nearly two generations, but they risk acting too forcefully,” the economist Maurice warned. Obstfeld.
Germany, Europe’s largest economy, is “heading into a winter recession”, says Munich-based research institute Ifo.
“A eurozone recession is on the cards as companies report deteriorating trading conditions and intensifying price pressures from soaring energy costs,” said Chris Williamson of S&P Global Market. Intelligence.
Even the United States, the world’s largest economy, is vulnerable. More than half of economists recently said it could enter a recession within the next 12 months.
In the UK, there are fears that the Bank of England‘s attempts to curb inflation by raising borrowing costs to 5% or more could tip the country into a damaging recession. Bailey has been accused of being ‘asleep at the wheel’ by not raising rates sooner and faster.
The risk now is that it goes too far in the other direction.
Either way, if the Governor and Chancellor fail to regain market confidence, borrowing costs are likely to rise. In the meantime, the priority is to restore calm – and not before time.
“Talking about a ‘market crash’ and a ‘pound crisis’ is an overstatement,” Jessop said. “It may take longer to convince investors and the general public, but the most important thing is to get it right economically. It’s a good start, despite the negative headlines.
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