Tue | Nov 29, 2022

British pound plunges to new low as tax cuts spark concern

Published:Tuesday | September 27, 2022 | 12:07 AM
People walk past a currency exchange bureau in London, Monday, September 26, 2022.
People walk past a currency exchange bureau in London, Monday, September 26, 2022.

The British pound fell to an all-time low against the US dollar early Monday after UK Treasury chief Kwasi Kwarteng pledged a sweeping package of tax cuts, fuelling concerns about the government’s economic policy as the United Kingdom teeters towards recession.

The pound fell as low as US$1.0373, its lowest level since the decimalisation of the currency in 1971, before rallying to above US$1.06 in London late-afternoon trading.

The weakening currency piles pressure on the United Kingdom’s new Conservative government, which has gambled that slashing taxes — and increasing borrowing to compensate — will spur economic growth. Many economists say it is more likely to fuel already high inflation, push down the pound, and drive up the cost of UK government borrowing — a potential perfect storm of economic headwinds.

The Bank of England said it is monitoring the drop in the pound and would not hesitate to boost interest rates to control inflation after doing so just last week. The central bank reiterated its intention to make a “full assessment’’ of the government’s tax and spending plans at its next meeting scheduled for November.

In a bid to reassure markets, the Treasury announced that it would set out a medium-term fiscal plan on November 23, alongside an economic forecast by the independent Office for Budget Responsibility. But the pound sank by two US pennies after both statements.

The British currency has been hammered since Friday, when Kwarteng announced the UK’s biggest tax cuts in 50 years.

The government plans to cut ₤45 billion (US$49 billion) in taxes as well as spend billions to help consumers and businesses struggling with high energy bills that are driving a cost-of-living crisis. The combination has sparked investor concern about spiralling government debt.

Kwarteng and Prime Minister Liz Truss, who took office three weeks ago, are betting that lower taxes and reduced bureaucracy eventually will generate enough additional tax revenue to cover government spending. Economists suggest it is unlikely the gamble will pay off.

Opposition Labour Party economy spokeswoman Rachel Reeves accused the government of “a return to trickle-down economics, an idea that has been tried, has been tested and has failed”.

“They are not gambling with their money – they are gambling with yours,” she told an audience at the party’s annual conference Monday.

The new and untested Truss, who replaced Boris Johnson as prime minister on September 6, also faces pressure from a nervous Conservative Party, which faces an election within two years.

Some Conservatives have welcomed the tax-cutting moves as a return to free-market values after years of state intervention in the economy during the coronavirus pandemic. But others worry that it is unconservative for the government to rack up huge debts that taxpayers will eventually have to pay.

Monday’s turbulence follows a three per cent fall in the pound Friday, the biggest one-day drop against the US dollar since Johnson announced Britain’s first COVID-19 lockdown on March 18, 2020. Before that, the pound lost more than 10 per cent of its value immediately after the UK voted to leave the European Union in June 2016 before rebounding.

The sense of a government losing control led some to compare current events with September 16, 1992 — ‘Black Wednesday’ — when a collapsing pound against the backdrop of high inflation forced the UK to crash out of the European Exchange Rate Mechanism, which was meant to stabilise exchange rates. It took the UK years to recover from the economic shock.

Kwarteng insisted that the government was acting responsibly – and said there were more tax cuts to come.

“We’ve only been here 19 days. I want to see, over the next year, people retain more of their income because I believe that it is the British people that are going to drive this economy,” he told the BBC.

AP