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.
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.”
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:
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.
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.
Today’s decision to abandon plans to scrap the 45% top rate of income tax paid by those earning more than £150,000 is a humiliating U-turn for the UK government, but the alternative was even worse.
Economically, it was unavoidable, our economics editor Larry Elliott writes:
A week of turmoil in the financial markets showed just how badly the mini-budget from the chancellor, Kwasi Kwarteng, had gone down with international investors. The pound fell, the cost of government borrowing rose, mortgage products were pulled.
Liz Truss’s government has made faster growth its central mission but the mini-budget was threatening to deliver the opposite to what the new prime minister had wanted: a brutal squeeze on activity caused by dearer imports and higher interest rates.
In itself, scrapping the top rate of tax was relatively small beer. Britain is a £2tn-plus economy and the cost of abolishing the 45% rate is estimated to be about £2bn a year. It made up less than 5% of Kwarteng’s £45bn package of tax cuts.
For the markets, though, the problem was that doing away with the top rate symbolised everything they didn’t like about the mini-budget: the fact that the tax cuts were unfunded, that they might lead to higher inflation, and that they were likely to prompt a tough response from the Bank of England. And, as Truss’s heroine Margaret Thatcher once put it: you can’t buck the markets….
Here’s Larry’s full analysis:
Resolution Foundation’s Torsten Bell also highlights that much of Kwasi Kwarteng’s unfunded pledges are still in place, despite the 45p top tax rate u-turn.
The oil price has jumped sharply this morning, on reports that the Opec+ cartel may cut production to support the market.
Opec and its allies meet on Wednesday, and are expected to discuss cutting production by over one million barrels per day in November – which would be the biggest reduction since early in the pandemic.
Oil producers are keen to prop up prices, after Brent crude fell to $84 per barrel last month, from over $120/barrel back in June.
Today, Brent is up almost 4%, back to $88.50/barrel.
The initial sterling rally seems to be fading, as investors ponder the scale of the UK’s economic challenges.
Having jumped almost two cents this morning, from $1.1088 to over $1.127 , the pound is back below $1.12 against the US dollar.
Russ Mould, investment director at AJ Bell, pooints out that there are still ‘plenty of problems’ – from the stretched public finances to the poor economic outlook.
The U-turn is important for two reasons.
First, the market was panicking about the cost of the tax cuts and how that would push up Government debt and in turn raise the prospect of reduced public spending and benefit cuts.
“Removing one of the key components of this seemingly flawed plan provided some relief, and you saw that in how the pound rallied and 10-year gilt rates briefly fell below 4%.
“The other factor to consider is that Kwarteng has effectively admitted to a massive policy error only weeks into his tenure as Chancellor. If Liz Truss is to establish any credibility as Prime Minister, can she afford to have anyone on her team who has effectively scored an own goal in the opening game?
“The fact that both the pound fell back and gilt rates started to move higher after the news had been digested is the market’s way of saying there are still plenty of problems with the Government’s finances, state of the consumer and business, and economic outlook.
With or without the 45% tax cut, the country still faces challenging times with individuals and companies finding life a lot harder.
Energy news: Britain is at “significant risk” of gas shortages this winter because of Russia’s war in Ukraine and undersupply in Europe.
Energy regulator Ofgem has said there was a possibility that Britain could enter a “gas supply emergency”. That would see supplies to some gas-fired power plants cut off, stopping them generating electricity.
The admission is likely to increase fears of blackouts because the UK relies on gas plants for the biggest share of its electricity supplies.
The Times has more details, explaining that power stations who were cut off could face huge charges to penalise them for not supplying electricity.
Bloomberg’s energy expert Javier Blas says it shows the urgent need to conserve energy (Liz Truss has opposed the idea of energy rationing ….)
Anti-poverty charity Oxfam have welcomed the decision not to cut taxes for Britain’s top earners.
Katy Chakrabortty, head of policy and advocacy at Oxfam GB, said:
“We are pleased that the Government has stopped, listened and understood that cutting taxes for the richest during a cost of living crisis is not the way to go. It needs to keep listening and provide urgent support to people facing poverty in the UK and those facing famine in other parts of the world.
“It is essential that ministers don’t seek to balance the books on the backs of people struggling to pay the bills and feed their families – public services, welfare and aid are all needed now more than ever.“
Abolishing the 45% top rate of tax, paid by those earning over £150,000, would have pushed up UK borrowing by £2bn per year.
Overall, the tax cuts in the mini-budget will cost £45bn by 2026/27, meaning extra borrowing or painful cuts to public spending.
Simon Clarke, the levelling-up secretary, warned late last week that public spending must be cut to help to fund the government’s £45bn of tax cuts.
But as Ben Chu of Newsnight points out, there is strong public opposition to any further austerity, given how stretched households and public services already are.
Abandoning the proposed removal of the 45p tax bracket eases some of the worries created by the mini-budget, but it is not a solution to the market turmoil, says Neil Birrell, chief investment officer at Premier Miton Investors.
Birrell points out that high inflation and high interest rates are not going away quickly, and economic growth is under severe threat, adding:
The Bank of England and the government are at loggerheads and, as importantly, there is no conviction in government policy. It all makes a for a very uncertain backdrop for markets, particularly gilts and sterling. However, markets move to discount the outlook quickly.
The rise in gilt yields has been dramatic and sterling has fallen to historic lows. In the meantime, UK equities have been relatively resilient and look cheap by international and historic comparison.
Birrell adds that:
A period of slow news and no surprises would help stabilise fears and volatility.”
Britain’s manufacturers have been hit by falling demand and soaring costs as the weak pound drove up import costs.
UK factory output fell for the third month running in September, with firms cutting production as their new orders fell for the fourth month in a row.
Firms were also hit by soaring input costs, which led them to hike their own prices at an accelerated rate too.
This pulled the closely-watched S&P Global / CIPS UK Manufacturing Purchasing Managers’ Index down to 48.4 in September, up from 47.3 in August.
That’s below the flash estimate of 48.5 (released on mini-budget day). Any reading below 50 shows a contraction.
The report found that companies faced tougher conditions in both domestic and export markets, with some orders being canned due to rising uncertainty, inflationary pressure and the cost-of-living crisis.
Dr. John Glen, chief economist at the Chartered Institute of Procurement & Supply, said:
Supply chain managers were buying less as customers either failed to place orders or cancelled work in hand. This slowdown was across the board as both domestic and export orders fell, impacted by concerns over transportation difficulties, disruptions in Felixstowe and longer lead times.
A shortage of components particularly made the completion of finished goods more difficult.
Glen adds that conditions may not improve in the last quarter of the year, given the economic unheaval”:
It is unlikely that supply chain managers will have hedged against the weaknesses in the pound for instance which will continue to impact on imports and what consumers will see on shelves as the shopping season begins in the coming months.”
Despite this morning’s U-turn, the damage in the bond market is still clearly visible, says Ben Laidler, global markets strategist at social investment network eToro
The UK government has bowed to the dramatic pressure from the financial markets today. Shelving the top rate of income tax cut provides short term relief to hard pressed Sterling and UK bond markets, but the government is not out of the woods yet with the vast majority of its unfunded spending plans still intact, from cuts to national insurance and basic income tax, to corporation tax and alcohol.
“Much of the damage from last week is also still visible, with 10-year bond yields up by a quarter from early September and by half from August, implying higher costs for all borrowers.”
https://www.theguardian.com/business/live/2022/oct/03/pound-rally-45p-tax-u-turn-recession-fears-markets-factories-business-live UK financial credibility ‘still damaged’ despite 45p tax rate u-turn; factory downturn continues – business live | Business