UK credibility ‘still damaged’ despite 45p tax rate U-turn
Chancellor Kwasi Kwarteng’s U-turn on the 45p tax rate does little to quell investor concerns about the UK, traders and economists say.
With sterling losing some of its earlier surge, William Marsters of Saxo UK, warns that the government’s credibility is still damaged:
“The rally in sterling up to 1.1281 versus the dollar has already pulled back to below the 1.12 level, highlighting it was a low-level relief.
The move to reverse the tax cut decision won’t add much to the government’s balance sheet and so will be seen more as a signal to investors than anything else.
As far as government credibility goes, investor concern might be more focused around the government’s disconnect internally with Prime Minister Truss saying the top-tier tax cut decision was made by Chancellor Kwarteng, and other cabinet members were not consulted on the matter.”
George Lagarias, chief economist at audit, accounting and consulting group Mazars, also warns that international investors are wary of UK assets:
“The Chancellor’s forced U-turn should take some pressure off the Pound, for the time being.
Still, the UK has lost some credibility with international markets over the past few years. Despite the Pound’s currency reserve status, British risk assets have a long and difficult way before they return as a staple in the portfolios of international long-term investors.“
Bethany Payne, global bonds portfolio manager at Janus Henderson Investors, warns the pound may remain ‘unloved’ for some time:
“In spite of a significant U-turn from the Chancellor, the currency moves have been fairly minor with sterling trading at similar levels to where it was on Friday and still just below the levels prior to the mini budget.
Meanwhile the Bank of England is in crisis talks with regulators to provide a more medium-term solution to backstopping pension fund strategies to prevent a repeat of last week’s market movements. The Bank of England has so far delayed the date of their own gilts sales to 31 October, in effect giving them and the government a four-week window for resolution.
While authorities dash to save the long-end of the bond market, Sterling still remains under its own unique pressures and we expect it to remain unloved for some time.”
Key events
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The Bank of England kept much of its firepower for calming the UK bond market dry today.
The UK central bank only accepted £22.1m of offers in its daily bond buy-back operation, and rejected £1.89bn of offers.
That operation to reduce strains in the gilt market was launched last Wednesday, with the BoE saying it would spend up to £65bn on long-dated gilts.
The move immediately calmed the panic in the bond market last week, lifting prices of long-dated debt and pulling down yields.
The Bank may have chosen to reject offers which it felt were overpriced, given the recovery in gilt prices after today’s 45p tax rate u-turn.
But…. the yield on 30-year UK gilts have now shot higher, as investors react to the Bank’s reluctance to accept offers today.
The decision to keep the 45p tax band for the highest earners may not protect the UK from a credit rating downgrade.
Credit rating agency S&P Global says the U-turn won’t have a material impact on its latest projections for the UK economy.
S&P rating analyst Maxim Rybnikov said.
“We consider that the decision to reverse the tax cuts for highest earners is not going to materially affect our fiscal and economic projections for the UK that we published last Friday.”
“We will continue to monitor government announcements, including possible future fiscal consolidation measures, and assess their impact on our negative outlook.”
Last Friday, S&P lowered its outlook on the UK’s AA sovereign credit rating to “negative” from “stable,” citing concerns about the country’s fiscal outlook and the ‘additional risks’ in lending to the UK.
It also estimated the UK budget deficit will widen by an average 2.6% of gross domestic product per year to 2025, due to the mini-budget measures.
The agency also warned that net general government debt will continue on an upward trajectory, “in contrast to our previous expectation of it declining as a percentage of GDP from 2023.”
Traders are betting it will take a bigger UK government policy U-turn to restore credibility with markets, reports Bloomberg:
The problem for investors is that the rest of the recent mini-budget, including borrowing billions to fund energy price caps and other tax cuts, is still going ahead, hurting the country’s debt sustainability. While the U-turn may slightly improve that outlook, it also damages the credibility of a government facing a revolt in its own party and a collapse in support in voter polls.
“The U-turn represents a concerted effort to soften the narrative regarding the government’s economic agenda but little to change the direction,” said Neil Mehta, a portfolio manager at BlueBay Asset Management.
“This dynamic should support the pound in the short-term, but we think this will be short-lived, as confidence in the government is shot and policies come home to roost over a difficult winter for the UK economy.”
Tees Valley mayor Ben Houchen, a Conservative, is pushing for a second U-turn, this time on the removal of the cap on bankers’ bonuses.
Our political correspondent Aubrey Allegretti reports:
Back in the markets, UK gilts are continuing to rally…. as the global bond market also strengthens.
The yield on benchmark 10-year UK government debt has now dropped to 3.88%, the lowest level since last Monday, down from 4.1% on Friday night.
That suggests the markets are still cautiously welcoming today’s decision to keep the 45p tax rate (as yields fall when investors pay a higher price for debt).
Other sovereign debt is in demand too, with German 10-year bunds down 14 basis points to below 2%, and 10-year US Treasuries down 11bp (or 0.11 percentage points) at 3.7%.
GAM Investments: Markets have little faith that Truss and Kwarteng can restore credibility
Market trust has been ‘shattered’ by the UK government’s push for unfunded tax cuts, warns Charles Hepworth, investment director at GAM Investments.
He believes it will be extremely hard for Liz Truss and Kwasi Kwarteng to restore credibility:
Sterling remains under pressure; the 45% tax rate only brought in a modest £2 billion of tax revenue, which is small change in the overall £700+ billion tax revenue for last year. Similarly, it does little to address wider market concerns of this unfunded budget – billions of pounds will still need to be borrowed.
“When market trust has been shattered, as we saw last week, the uphill task of restoring credibility is extremely hard and even harder when strategies shift.
The market currently has little faith that the Prime Minister and Chancellor can restore credibility in the short term, and this puts further renewed pressure on UK risk assets.”
Resolution: Top earners still main winners from regressive mini-budget
Kwasi Kwarteng’s mini-budget is still deeply regressive, the Resolution Foundation warns, even though the 45p top rate of tax is no longer being axed.
Resolution have calculated that the richest 5% of households have just lost almost two thirds of the cash gains from the mini-budget.
But even so – they still stand to gain £3,500 on average next year from the tax cuts announced in the Chancellor’s recent Fiscal Statement, or a quarter of the whole package.
That’s almost 40 times as much as the poorest fifth of households, who get just an extra £90 to help them through the cost of living crisis.
Here’s the key findings from Resolution:
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Smaller tax cuts at the top. Scrapping the abolition of the 45p tax rate removes 62 per cent of the cash gains going to the richest 5 per cent of households, and 54 per cent of the gains going to the richest 10 per cent.
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Still a very regressive policy package. A quarter of the cash gains from the remaining tax cuts package are going to the richest 5 per cent of households – far more than the 16 per cent of cash gains spread across the entire bottom half of the income distribution.
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Richest households will gain almost 40 times as much as poorer families. The top 5 per cent of households are still set to gain £3,500 on average next year from the remaining tax cuts, compared to just £90 on average for the poorest fifth of households.
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Chancellor still has tough choices to make before 23 November. The remaining £43 billion of unfunded tax cuts still leave the Chancellor on course to miss his fiscal target of having debt falling in the medium-term. Unless further U-turns are made, the Chancellor will need to announce significant spending cuts on 23 November. The scale of those spending cuts is largely unchanged by today’s U-turn.
Lalitha Try, researcher at the Resolution Foundation, warns that Kwasi Kwarteng may announce significant spending cuts next month:
“The welcome decision this morning to scrap the abolition of the 45p tax rate has made the Chancellor’s package of tax cuts less focused on the very richest households. But the top are still the main winners, and the scale of spending cuts required to pay for them is largely unaffected.
“Despite today’s U-turn, the richest 5 per cent of households still stand to gain far more than the entire bottom half of the income distribution combined.
“The Chancellor remains wildly off-course in meeting his fiscal target of having debt falling in the medium-term, and is on course to announce significant new spending cuts on 23 November as a result.”
Eurasia Group: expect MPs to revolt over other measures
Today’s dramatic U-turn on the 45p rate sends an immediate signal to Conservative MPs that they hold the whip hand over this new government, explains Mujtaba Rahman, managing director for Europe at Eurasia Group.
Rahman writes that other elements of Kwarteng’s mini-budget package are now at risk too:
Barely a month into the new government it represents a massive loss of authority for Liz Truss and Kwasi Kwarteng, who were insisting as late as last night that the plan would go ahead.
The lesson will not be lost on Downing Street that the Government, even with a working majority of 71, is vulnerable to an alliance of its own MPs and the opposition MPs if it pushes its radical vision too far.
Rahman adds that further revolts are highly likely:
The episode highlights Truss’ lack of support on her own backbenches—and downright hostility from some critics, including allies of Rishi Sunak, her opponent in the Tory leadership contest. They will now scent weakness; Truss’ attempt to display strong leadership has been undermined.
Fresh revolts seem almost certain on the plan to lift the cap on bankers’ bonuses and the swingeing public spending cuts that appear inevitable if ministers are to convince the Office of Budget Responsibility and the markets that they can cover the massive borrowing necessary to finance the remainder of the tax cuts and help with energy bills promised by Kwarteng in the mini-budget.
These, such as de-linking benefit payments from inflation, as well as other controversial elements of the government’s supply side agenda, including plans to scrap EU rules over maximum weekly working hours, housebuilding and fracking will now be at risk.
SEC charges Kim Kardashian over crypto security promotion
In other news… reality TV superstar and influencer Kim Kardashian has been charged with promoting a crypto security without disclosing she had been paid.
The US Security and Exchange Commission has announced that Kardashian failed to disclose a $250,000 payment she received for touting a crypto asset offered and sold by EthereumMax on her Instagram feed.
Kardashian has agreed to pay a $1,000,000 penalty, plus approximately $260,000 in ‘disgorgement’ (returning her payment), without admitting or denying the SEC’s findings.
The SEC says:
The SEC’s order finds that Kardashian failed to disclose that she was paid $250,000 to publish a post on her Instagram account about EMAX tokens, the crypto asset security being offered by EthereumMax. Kardashian’s post contained a link to the EthereumMax website, which provided instructions for potential investors to purchase EMAX tokens.
“This case is a reminder that, when celebrities or influencers endorse investment opportunities, including crypto asset securities, it doesn’t mean that those investment products are right for all investors,” said SEC Chair Gary Gensler.
“We encourage investors to consider an investment’s potential risks and opportunities in light of their own financial goals.”
UK credibility ‘still damaged’ despite 45p tax rate U-turn
Chancellor Kwasi Kwarteng’s U-turn on the 45p tax rate does little to quell investor concerns about the UK, traders and economists say.
With sterling losing some of its earlier surge, William Marsters of Saxo UK, warns that the government’s credibility is still damaged:
“The rally in sterling up to 1.1281 versus the dollar has already pulled back to below the 1.12 level, highlighting it was a low-level relief.
The move to reverse the tax cut decision won’t add much to the government’s balance sheet and so will be seen more as a signal to investors than anything else.
As far as government credibility goes, investor concern might be more focused around the government’s disconnect internally with Prime Minister Truss saying the top-tier tax cut decision was made by Chancellor Kwarteng, and other cabinet members were not consulted on the matter.”
George Lagarias, chief economist at audit, accounting and consulting group Mazars, also warns that international investors are wary of UK assets:
“The Chancellor’s forced U-turn should take some pressure off the Pound, for the time being.
Still, the UK has lost some credibility with international markets over the past few years. Despite the Pound’s currency reserve status, British risk assets have a long and difficult way before they return as a staple in the portfolios of international long-term investors.“
Bethany Payne, global bonds portfolio manager at Janus Henderson Investors, warns the pound may remain ‘unloved’ for some time:
“In spite of a significant U-turn from the Chancellor, the currency moves have been fairly minor with sterling trading at similar levels to where it was on Friday and still just below the levels prior to the mini budget.
Meanwhile the Bank of England is in crisis talks with regulators to provide a more medium-term solution to backstopping pension fund strategies to prevent a repeat of last week’s market movements. The Bank of England has so far delayed the date of their own gilts sales to 31 October, in effect giving them and the government a four-week window for resolution.
While authorities dash to save the long-end of the bond market, Sterling still remains under its own unique pressures and we expect it to remain unloved for some time.”
The pound has recovered to its highest level against the euro since the mini-budget, up half a eurocent at €1.145 so far today.
A week ago, sterling hit its lowest point against the euro since the end of 2020, just €1.0832, as markets reeled from the unfunded commitments in the mini-budget.
But it strengthened once the Bank of England stepped in last Wednesday with a pledge to buy long-dated UK government debt to avoid a collapse in the pensions market.
It’s still down over 3% against the euro this year, though:
Truss still has confidence in Kwarteng, spokesman says
Liz Truss’s spokesman has said the prime minister still has confidence in chancellor Kwasi Kwarteng, following today’s humiliating u-turn on scrapping the 45p top rate of tax for earnings over £150,000.
Asked whether Truss still had confidence in Kwarteng, the spokesman said: “Yes”, Reuters reports.
The spokesman said he was confident parliament would approve the rest of Kwarteng’s mini budget, which helped spark turmoil in financial markets and a rebellion in her Conservative Party.
IFS: Chancellor still has lots of work to do
Kwasi Kwarteng must consider more u-turns, or make cuts to public spending to fund his mini-budget, warns the Institute for Fiscal Studies.
IFS Director Paul Johnson says the chancellor still has a lot of work to do if he is to show a credible commitment to fiscal sustainability:
“The direct impact of the government’s U-turn on the abolition of the additional 45p rate of income tax is of limited fiscal significance. At a medium-run cost of around £2bn a year, it represented only a small fraction of the Chancellor’s mini-Budget announcements. His £45bn package of tax cuts has now become a £43bn package – a rounding error in the context of the public finances.
The Chancellor still has a lot of work to do if he is to display a credible commitment to fiscal sustainability.
Unless he also U-turns on some of his other, much larger tax announcements, he will have no option but to consider cuts to public spending: to social security, investment projects, or public services. On the latter, the Chancellor has indicated that departments’ cash spending plans that run to 2024-25 will be left unchanged, which amounts to a real-terms cut in their generosity in the face of higher inflation.
This will squeeze public services, but will not be enough to plug the fiscal hole the Chancellor has created for himself.”
The IFS has worked out that reversing the rise in national insurance rates will cost £16bn per year, while bringing forward the 1p cut in basic rate income tax by a year will cost £5bn.
Cancelling the planned increase in corporation tax was one of the biggest measures in the mini-budget, expected to cost over £18bn by 2026/27.
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