Status: 10/17/2022 6:03 p.m
After the announcement of massive tax breaks caused turbulence in the markets, the new UK budget plan brings some calm. In addition to the pound, bonds are also in demand.
The new British finance minister, Jeremy Hunt, eased the tension on the financial markets with his announcement that he would collect the controversial tax plans and reduce spending. The pound temporarily rose by up to 1.4 percent to $1.1332. British government bonds were also in high demand.
Hunt wants to rebuild trust
Finance Minister Jeremy Hunt, who has only been in office since Friday, announced the about-face in London today: “We will change almost all the tax measures that we announced three weeks ago in the growth plan.” The country must now raise taxes and limit spending to restore confidence and ensure stability, said the former health and foreign minister, who is seen as the new strongman in government. Nevertheless, it is still a question of ensuring more economic growth. But that also requires a certain stability.
The tax cuts worth billions and not counter-financed as well as high spending to dampen energy prices were presented by former Finance Minister Kwasi Kwarteng, who was dismissed by the new Prime Minister Liz Truss at the end of last week. Together they had worked out the plans, which had a devastating effect on the markets.
The announcement had plunged stock markets into the worst turmoil in years, sending the pound to record lows against the dollar. The bond market was an indicator of the nervousness on the markets and the loss of confidence in British budgetary policy. Investors dumped UK government bonds from their portfolios fearing that the country would default on future debt due to growing new debt. Prices tumbled, with yields on 30-year paper topping 5 percent – twice what they were in August. Pension funds in particular ran into liquidity problems due to their complex derivative constructions.
Coordination with UK Central Bank
As a result, the Bank of England (BoE) had to counteract this with an emergency purchase program for bonds in order to calm investors and take pressure off the pension funds and thus also the banks. If the prices of government bonds fall very quickly, as in the British case, pension funds have to pay their business partners – often banks or investment companies – additional collateral. The funds have to sell parts of their portfolios to get the financing, but investors no longer want long-term British bonds. In the worst case, this would have led to the insolvency of the funds, which would probably have triggered a financial crisis.
For this reason, the British central bank announced at the end of September that it would buy up to 65 billion pounds (73.5 billion euros) of current British government bonds by October 14. After another price slide, she announced only four days before the scheduled end of the emergency purchase program that she would double the daily purchase limit and also buy other securities by November 10th. According to his ministry, the new Finance Minister Hunt met with the head of the British central bank, Andrew Bailey, yesterday evening to present and coordinate his plans in advance.
Kwarteng had been accused of undermining the interest rate hikes by the central bank in the fight against high inflation with his loose financial policy. Originally, for two years, he had planned to relieve households and companies from the sudden increase in energy costs in the wake of the war in Ukraine. The cost of this has been estimated at more than £100 billion (€116 billion). High-income people in particular should also benefit from this. Truss and Kwarteng argued that this would boost the economy, which would lead to more growth and thus higher tax revenues – so the reform would, to a certain extent, finance itself.
Changing course will save £32 billion a year
However, investors and economists did not believe in it. Instead, they feared massive collateral damage – with the risk that the kingdom’s already severe economic and financial problems would worsen further with the new government’s fiscal policy course. In addition to concerns about rising government debt, the planned relief threatened to increase inflationary pressure even further.
Prime Minister Truss had already made a U-turn on Friday and said goodbye to a key part of her reforms. Hunt has now cashed in on the tax cut and stimulus package in full. The program is due to end in April and will then be replaced by more targeted measures for the most vulnerable households.
That should cost taxpayers significantly less. The basic tax rate of 20 percent should also remain in place. Hunt put the savings from the change in tax plans at £32 billion a year. According to the “Sunday Times”, the budget deficit amounts to up to 72 billion pounds, i.e. the equivalent of a good 83 billion euros. At the end of October, Hunt wants to present more details about the medium-term financial planning. Today he wanted to explain the details to Parliament.
Hope for a more sustainable budgetary policy
His budget was also well received by German investors. After the turbulence of the past week, the leading index DAX rose by more than two percent in the afternoon. The EuroStoxx50 also gained more than two percent. “Following last week’s events and the sacking of the previous Treasury Secretary, the UK government has taken a number of steps to boost market confidence,” said Markets.com researcher Neil Wilson.
Even if all the fiscal measures that scared investors are rolled back, credibility won’t be easily restored, he warned. “Investors are hoping that Jeremy Hunt is a more reliable Treasury Secretary,” said Ben Jones, senior analyst at wealth manager Invesco. It remains to be seen how Hunt will fare in the long term and whether Prime Minister Truss will remain in office.
Nonetheless, the prospect of a more sustainable budgetary policy prompted investors to take hold of British government bonds. This pushed yields on ten-year British bonds back below four percent to as high as 3.914 percent.