British Prime Minister Liz Truss reversed course after plans for sweeping tax cuts sparked weeks of market turmoil, sacked the finance minister behind the proposal and insisted the government would stick to “fiscal discipline”.
“It’s clear that portions of our mini-budget have gone further and faster than markets expected,” Truss said at a news conference today. “Therefore, the way we fulfill our mission now needs to change. We must act now to reassure the markets of our fiscal discipline.”
Kwasi Kwarteng, Britain’s Chancellor of the Exchequer and the main architect of the tax cuts announced by the Truss government late last month, resigned after less than six weeks in office. The tax cuts, if fully implemented, would have been the largest in 50 years and would have saved about $48 billion in taxes. Kmacheng will be replaced by former Health Secretary James Hunt.
The central theses
- UK FX and bond markets were shaken after the tax cut announcement
- The Bank of England (BoE) intervened to stabilize UK bond markets
- Kwasi Kwarteng, Britain’s Chancellor of the Exchequer under the Truss administration and the main architect of Britain’s recent tax cuts, has been sacked
- The tax cuts announced by Kwarteng in late September would be the largest in 50 years and would total $48 billion if fully implemented.
- The tax plan met with widespread criticism abroad, including from the International Monetary Fund (IMF)
Tax cuts trigger financial turbulence
UK markets slumped after the tax plans were announced amid growing concerns about fiscal sustainability and debt ability. Critics, including some members of the prime minister’s own party, said the plan could widen the budget deficit and accelerate inflation at a time when the nation was already facing an economic slowdown and an energy crisis. UK inflation is nearing 10%, the highest since 1982, as energy costs soar.
The pound plummeted to a record low of $1.03 near parity against the US dollar in the days following the announcement, amid a sharp sell-off in UK bond markets. The yield on the 10-year gilt rose to over 4%, its highest since 2008.
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British politicians are trying to calm the markets
UK tax and monetary authorities took contingency action to calm markets. The Truss administration, led by Kwarteng, scrapped a key component of the original tax plan that would have lowered the top income tax rate from 45% to 40%.
The Bank of England (BoE) said on September 28 that it would resume its bond-buying or quantitative easing (QE) program to stabilize the bond market. The pound eventually rallied to a high of $1.14 on October 4th. Since then it has weakened to $1.12.
Rare criticism from the IMF
The tax cuts met with widespread criticism abroad. In a rare statement criticizing an advanced economy, the International Monetary Fund (IMF) advised against it, saying fiscal and monetary policies should not be at odds. The IMF also said tax cuts would likely “increase inequality” and would not be recommended as global inflation accelerates.
Former Treasury Secretary Larry Summers, professor emeritus at Harvard University, also criticized the plan, tweeting: “I can’t remember a G10 country that had that much debt sustainability risk in its own currency. The first step to regaining credibility is not to say incredible things.”
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