The pound has fallen to a fresh 37-year low
The government of Liz Truss has made a bold declaration of intent; her mission is clear, but its effectiveness is still up for debate. If it does, the Pound will have a better future; if it doesn’t, record lows will undoubtedly beckon. Following Chancellor Kwasi Kwarteng’s announcement of fiscal measures, the British pound experienced a significant decline.
From 10:40 BST onward, a significant sell-off hit the currency abruptly and continued throughout the U.S. equity trading day. In order to promote UK economic growth, Kwarteng pledged considerable tax burden reductions in his Growth Plan 2022. The changes represent the largest tax reduction initiative since 1972.
The market is sceptical of how the new cuts, as well as the billions spent on capping energy prices, will be funded, as seen by the rise in UK government borrowing costs and the decline in the Pound.
According to Daragh Maher, head of FX Strategy, US at HSBC plc, “marked GBP weakening shows that any cyclical support for the currency from the fiscal impetus is being outweighed by concerns over the significant strain these measures will have on government finances.”
The ‘dual deficits’ structural bearish case for the pound sterling is becoming more prominent, according to Maher, as the UK’s external balance is already declining substantially (the core balance is running at close to 8% of GDP). A 100 basis point increase at the Bank of England in November is now expected by traders, according to pound market pricing.
This indicates that the market thinks the government’s actions will spur growth, but critically, growth that will spur longer-term inflation. The yields paid on five-year UK government bonds increased by 50 basis points, on track to experience their highest increase ever. Yields for ten years were at seven-year highs.
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The administration passed the largest tax cut package since 1972, even bigger than those introduced by Nigel Lawson, Margret Thatcher’s chancellor.
A major announcement is the reduction of the basic income tax rate from 20p to 19p beginning in April 2023.
According to the government, the highest rate of income tax was reduced from 45p to 40p in order “to attract global talent and encourage enterprise.” Government bonds decreased as a result of the changes, which amount to a large increase in the UK’s tax burden. The administration also provided a rough cost estimate for its new policies. In a few years, the cost of the tax cuts alone will total £45BN.
Other initiatives include lowering the threshold at which first-time homebuyers must pay stamp duty (it was formerly £300k).
Properties up to £625K are now eligible for first-time buyer relief, up from £500K. For all buyers, the nil-rate bracket will increase by 50% to £250k.
The government will eliminate the Health & Social Care Levy and reduce National Insurance by 1.25 percentage points as of November 6. The Kwarteng feels that freezing alcohol duty in February 2023 will aid in the hotel sector’s recovery.
Kwarteng claims that starting on April 1, 2023, the Annual Investment Allowance would be permanently fixed at its highest level ever of £1 million in order to help firms in making investments and expanding.
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Businesses investing up to £1 million in plant and equipment will receive a 100% tax deduction. As a result, the rate will remain at 19%, the lowest in the G20, notwithstanding the cancellation of the scheduled increase to 25%.
In the meantime, the government has reached an understanding in principle with 38 regions to create tax-cutting Investment Zones that will spur growth and free up the construction of new homes. Over the next weeks, new legislation to restructure planning authorization for significant infrastructure projects would also be introduced.
The government of Liz Truss has made a bold declaration of intent; her mission is clear, but its effectiveness is still up for debate. If it does, the Pound will have a better future; if it doesn’t, record lows will undoubtedly beckon.
