It will take more than a partial change to restore investor confidence
The British Government has “listened” to the financial markets. Prime Minister Liz Truss on Monday scrapped the most controversial proposal in her so-called growth plan: the abolition of the 45% tax rate for the highest incomes. But it will take more than a partial turnaround to restore global investor confidence.
The turn of Truss and the chancellor (minister) of Finance, Kwasi Kwarteng, is welcome. The “mini-budget” announced on September 23 sent UK 10-year government bond yields soaring to 4.6%, and forced the Bank of England to announce a plan to purchase bonds worth 65,000 million pounds (75,000 million euros) to rescue the country’s pension funds. The top-rate tax cut proved toxic even among Truss’s Conservative MPs.
Despite the change in course, investors still have reason to worry about the government’s fiscal policy, which is going to double debt to almost 4% of GDP in 2027, according to the Institute for Fiscal Studies (IFS). Maintaining the 45% tax rate will save the government about 6 billion pounds (7 billion euros) a year, or 0.3% of GDP. But two other worrying measures remain on Truss’s agenda: the cancellation of a planned rise in social security contributions and an increase in the corporate tax rate. According to the IFS, these measures alone will cost the British Treasury more than 31,000 million pounds (36,000 million euros) a year. This is added to the limitation of the price of energy, which will cost 60,000 million (69,000 million) in six months.
So far, the government has not explained how it will finance these tax gifts, apart from vague hints of further spending cuts and faster growth. Investors will therefore remain concerned, even if Truss embarks on a destructive austerity policy, which will hit growth and create political instability.
In the longer term, confidence in the Truss government, and the resilience of British institutions, may have weakened. Announcing a huge stimulus plan at a time of full employment, runaway inflation, and an 8% current account deficit was always going to backfire. The government’s decision to go ahead without scrutiny from Britain’s fiscal watchdog, the Office for Budget Responsibility, also sets a bad precedent.
After Kwarteng announced his change of course, the yields of the gilts The government’s 10-year bonds fell briefly, but were still about 0.5 percentage point higher than on September 22, the day before the mini-budget announcement. And the British pound is still down almost 3% against the dollar since Prime Minister Truss took power on September 6. For both Truss and Kwarteng, the road to economic credibility will be long and arduous.