Kwasi Kwarteng’s speech to the House of Commons today lasted 25 minutes and 16 seconds and in it he committed to an additional £72.4 billion in borrowing. For every second the Chancellor spoke, the UK committed itself to £48m in new debt.
But even before Shadow Chancellor Rachel Reeves had started speaking, the cost of the fiscal event had risen higher as markets reacted to the announcement. UK government bond prices, known as gilts, fell and yields (the premium the government pays on debt) on five- and 10-year bonds rose sharply after the announcement, reflecting the huge borrowing the government plans to can increase even more expensive. The difference between the cost of borrowing (over a 10-year bond) from the UK government and the German state has become wider than at any time in more than 20 years.
The pound, already pushed to a 37-year low by market expectations of a recession, fell sharply against both the dollar and the euro, hitting $1.10 about an hour after Kwarteng’s speech. The price of options contracts is now forecasting a 17 percent chance that the pound and dollar will reach parity this year.
The FTSE 100 index with a market capitalization of 1.9 trillion £ also fell. At the time of writing, the UK’s 100 largest companies had collectively lost about 2 per cent of their market value.
The scale of the market reaction has partly to do with the sheer size of the announced measures, which include £45bn in tax cuts and an energy pricing plan that will cost £10bn a month. Paul Johnson, director of the Institute for Fiscal Studies, commented that markets were “terrified”. [the] Scope of tax gift”.
Overall, however, it is also an indication of investor confidence in the UK economy and the extent to which market participants believe the government’s tax cuts will deliver the promised GDP growth.
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Samuel Tombs, chief economist at Pantheon Macroeconomics, commented that GDP growth from the promised measures, which include scrapping the 45 per cent personal income tax rate on earnings over £150,000, will be “relatively modest considering the biggest winners are high earners whose spending is less sensitive to changes in their income. In fact, these households are already cash rich, having saved unusually large sums during the pandemic.”
The market reaction also suggests that investors are anticipating higher interest rates. In a note describing the mini-budget as “a perfect storm for UK gilts and forex,” economists at Dutch bank ING said that “the recent jump in [gilt] Yields imply that [the] Bank rates will peak well over 5 percent next year.”
Some measures were welcomed by companies as promoting growth. Shevaun Haviland, Director-General of the UK Chambers of Commerce, commented that the reversal of social security contributions and the removal of the IR35 payroll rule “should boost economic growth, ease cost pressures and encourage investment”.
However, Haviland also concluded, “All eyes will now turn to the Office of Budget Responsibility (OBR) forecasts in the fall for reassuring public finances.” Investors and companies have had to make up their own minds about the likely impact of the today’s fiscal event after the Treasury Department refused to release the OBR’s analysis of conditions in an economy that has changed significantly since the OBR’s last forecast in March. This will only have made the market’s reaction to the already highly controversial (and by no means small) mini-budget even more volatile.
[See also: Liz Truss has taken the biggest ideological gamble for 40 years]