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U.K. Markets Rise as New Chancellor Axes Truss’s Tax and Spending Plans U.K. Markets Rise as New Chancellor Axes Truss’s Tax and Spending Plans
(about 5 hours later)
Britain’s pound and government bonds rose on Monday as the nation’s new finance minister said he was reversing almost all of the tax and spending plans of Prime Minister Liz Truss that were announced a few weeks ago and sent markets into turmoil. The decision by Britain’s new finance minister to tear up almost all of Prime Minister Liz Truss’s tax and spending plans restored some hoped-for calm to British markets on Monday, but investors are still left with many questions about the future of the nation’s economy and public finances.
Jeremy Hunt, the chancellor of the Exchequer, on his third full day in office, said he was canceling most of the tax cuts announced by his predecessor on Sept. 23. He also dismantled part of Ms. Truss’s first landmark policy — a cap on household energy bills that was set to last through to 2024. Mr. Hunt said he would only guarantee that bills would be frozen until April. Prices in Britain are soaring at the highest rates in four decades, a pace of inflation that is expected to prompt further interest rate increases from the Bank of England in coming months, even as the economic slowdown threatens to turn into a recession.
The decisions were a huge capitulation to pressure in financial markets, where the British pound fell to a record low against the dollar and government bond yields soared, pushing up home mortgage rates and government borrowing costs. The tumult was precipitated by Ms. Truss and her previous chancellor, Kwasi Kwarteng, pledging widespread tax cuts, including for the highest earners, that would be funded by borrowing. Investors rebuffed the plans, anticipating they would worsen Britain’s inflationary problem and put the nation’s debt on an unsustainable path. Jeremy Hunt, on his third full day as chancellor of the Exchequer, said he was canceling most of the tax cuts announced by his predecessor on Sept. 23, which had sent markets into turmoil. He also dismantled part of Ms. Truss’s first landmark policy — a cap on household energy bills that was set to last through to 2024. Mr. Hunt said that he would guarantee only that bills would be frozen until April and said a less expensive policy would be devised to follow.
“We will reverse almost all the tax measures announced in the Growth Plan three weeks ago that have not started parliamentary legislation,” Mr. Hunt said in a televised statement on Monday morning, adding that he was focused on bringing about economic stability. The decisions were a huge capitulation to pressure in financial markets, where, in recent weeks, the British pound fell to a record low against the dollar and government bond yields soared, pushing up home mortgage rates and government borrowing costs. The tumult was precipitated by a pledge by Ms. Truss and her previous chancellor, Kwasi Kwarteng, to provide widespread tax cuts, including for the highest earners, financed by borrowing. Investors rebuffed the plans, anticipating that they would worsen Britain’s inflation problem and put the nation’s debt on an unsustainable path.
Bond prices climbed on Monday, pushing the yield on 10-year bonds down to 3.94 percent, from 4.3 percent on Friday. The pound rose about 1 percent against the dollar, to nearly $1.13. “We will reverse almost all the tax measures announced in the growth plan three weeks ago that have not started parliamentary legislation,” Mr. Hunt said in a televised statement on Monday morning, adding that he was focused on bringing about economic stability.
Mr. Hunt will give a statement in the House of Commons this afternoon but said he wanted to give a summary of the announcements early because they were “market sensitive.” Bond prices climbed on Monday, pushing the yield on 10-year bonds down to 3.98 percent, from 4.3 percent on Friday. The pound rose more than 2 percent against the dollar, to $1.14.
Among the scrapped measures, Mr. Hunt said he would indefinitely postpone a plan to cut the lowest income tax rate in Britain. Mr. Hunt said he would indefinitely postpone a plan to cut the lowest income tax rate in Britain, one of the most surprising scrapped measures.
“At a time when markets are rightly demanding commitments to sustainable public finances, it is not right to borrow to fund this tax cut,” he said.“At a time when markets are rightly demanding commitments to sustainable public finances, it is not right to borrow to fund this tax cut,” he said.
Mr. Hunt’s efforts to calm markets began even before bonds started trading on Monday. Monday’s U-turns were “probably enough to stabilize the situation,” said Dean Turner, an economist at UBS Wealth Management. But the markets are probably “stuck around these levels,” he added, until either there’s a change in leadership or Mr. Hunt delivers further details on the fiscal plan, which he is scheduled to do on Oct. 31.
Two surprise statements issued early in the morning showed the extent of the nervousness among British officials about whether markets were about to begin another week of turmoil: The Treasury said Mr. Hunt would bring forward by two weeks some measures to “support fiscal sustainability,” and the Bank of England issued a statement reiterating that it had ended its bond-buying intervention in the market that helped pension funds, but that other measures were still in place to support liquidity. “Until one of those things happens I can’t really make a case either way to see sustained moves here,” Mr. Turner said.
Monday was set to be a day of judgment for Britain in the financial markets. It marked the first trading session since the central bank ended a program that spent more than £19 billion (about $21 billion) buying bonds to end dysfunction in the market over the past two and a half weeks. It also was an opportunity for investors to reappraise the plans for Britain’s public finances, after the previous chancellor, Mr. Kwarteng, was sacked on Friday and some of the government’s recently announced tax plans were undone. In a sign of the lingering uncertainty, bond investors haven’t completely reversed their moves since the Sept. 23 statement, even though most of the policies have been dumped. Britain’s bond yields — a measure of government borrowing costs — remain significantly higher. For example, the yields on five-year bonds on Monday closed at 3.94 percent, up from 3.56 percent on Sept. 22.
The Treasury statement began to soothe financial markets, as bond prices (which move inversely to yields) and the pound continued to trade higher after Mr. Hunt’s announcement. Mr. Hunt said scrapping the tax cuts would raise 32 billion pounds (about $36 billion) a year but warned that “difficult decisions” would still need to be made on spending, with every government department being asked to find more cuts despite already stretched budgets.
But investors haven’t completely reversed their moves since the Sept. 23 statement, even though most of the policies have been dumped. Britain’s bond yields remain significantly higher, reflecting the uncertainty ahead about the government’s credibility. For example, five-year yields were trading at 3.91 percent on Monday, up from 3.56 percent on Sept. 22. “Fiscal credibility is hard won but easily lost,” Paul Johnson, the director of the Institute for Fiscal Studies, a London think tank, said in a statement. Monday’s announcements “won’t be enough, by themselves, to plug the gap in the government’s fiscal plans,” he said. “Nor will they be enough to undo the damage caused by the debacle of the last few weeks.”
Mr. Hunt said that scrapping the tax cuts would raise £32 billion. But to bring debt levels down a gap in the public finances would still need to be plugged. The new chancellor warned that “difficult decisions” would need to be made on spending, with every government department being asked to find more cuts, despite their already stretched budgets. More spending decisions are expected in two weeks. On Oct. 31, Mr. Hunt will release a full “medium-term fiscal plan,” which is set to include how the government plans to reduce Britain’s debt burden, the same day that the Office for Budget Responsibility, a government watchdog, delivers its independent assessment on the economic and fiscal impact of the policies. At the end of August, government debt was about 97 percent of gross domestic product, and the government said it would make debt fall as a percentage of national income in the medium term.
Meanwhile, speculation is growing that Ms. Truss may not be able to hold onto her position as prime minister much longer, now that her tax-cutting agenda has been left in tatters. “Mr. Hunt will still have to make some scary decisions on tax and spend this Halloween,” Mr. Johnson said. “And it remains hard to see where significant spending cuts could come from.”
A full “medium-term fiscal plan,” which will include how the government plans to reduce Britain’s debt burden and the “difficult” spending decisions that will be made, will still be delivered on Oct. 31, alongside an independent assessment on the economic and fiscal impact of the policies by the Office for Budget Responsibility, a government watchdog. Adding to uncertainty is growing speculation that Ms. Truss may not be able to hold on to her position as prime minister much longer, now that her tax-cutting agenda has been left in tatters.
“No government can control markets, but every government can give certainty about the sustainability of public finances and that is one of the many factors influencing how markets behave,” Mr. Hunt said on Monday. While Mr. Hunt has undone Ms. Truss’s policies, the government still needs to set out a strategy to tackle Britain’s economic challenges, including high inflation, weak productivity, lackluster investment growth and the trade ruptures brought about by Brexit.
“The calamitous events of the past few weeks will not have done anything to tackle the lack of investment growth that has been evident in the U.K. in recent years, nor will it have impacted the wide current account deficit,” Jane Foley, a strategist at Rabobank, wrote in a note.
“There is still too much uncertainty in both the U.K. economic and political outlooks for us to turn constructive” on the pound, Ms. Foley wrote.
Monday was set to be a day of judgment for Britain in the financial markets. It was the first trading session since the Bank of England ended a program that spent more than £19 billion (about $21 billion) buying bonds to end dysfunction in the market over the past two and a half weeks. It was also an opportunity for investors to reappraise the plans for Britain’s public finances without the central bank’s intervention.
Even as Britain’s government bond yields fell on Monday, the longer-term trend is for yields to rise, said Imogen Bachra, an interest rates strategist at NatWest.
“The question marks still remain around fiscal sustainability,” Ms. Bachra said.
At the same time, the Bank of England will continue to raise interest rates as it tackles the inflation rate, which was 9.9 percent in August. On Saturday, Andrew Bailey, the governor of the central bank, said he expected interest rates to rise more than previously expected given the government’s fiscal plans.
Traders are betting that the bank will need to raise interest rates to more than 5 percent next year, from 2.25 percent at the moment, although this level is lower than that expected in the immediate aftermath of the Sept. 23 statement.
Adding pressure to the bond market, analysts at NatWest say, is the need for investors to absorb debt issued to help pay for the cap on energy bills, at the same time that the central bank is planning to sell bonds back to the market.
“We still are in a rising yield environment,” Ms. Bachra said. The outlook for the supply of government bonds into the market “hasn’t been dramatically altered despite the U-turns on the tax policies.”