New UK government rolls the dice with high stakes budget

It is always good to have a surprise on budget day. But having a shock is not such a good idea. UK chancellor Kwasi Kwarteng no doubt hoped to win over the Tory heartlands by slashing the top income tax rate from 45 per cent to 40 per cent in his Friday mini-budget. But a move which both he and prime minister Liz Truss no doubt saw as a bold manoeuvre only served to underline to the financial markets that the Conservatives were planning to cut taxes at precisely the same time as spending would soar due to energy supports, including a cap on energy bills the cost of which is impossible to calculate.

Soaring spending and lower taxes means only one thing — more borrowing. The market reaction was savage. The interest rate at which investors are prepared to extend long-term loans to the UK state rose by more than half a percentage point this week to not far off 4 per cent . Meanwhile sterling has dropped, reaching its lowest level against the dollar since 1985 and investors are betting that the Bank of England will have to push up short-term interest rates even more rapidly to counteract the inflationary boost of the mini-budget. It is a huge gamble and there is no obvious fallback plan. During Covid-19, governments had significant cover in their budget policies due to the expansionary policies of central banks. This era is now over as central banks, including the Bank of England, seek to clamp down on runaway inflation.

The initial market reaction to the mini-budget suggests that a full blown sterling crisis is now possible. Mr Kwarteng is betting that his tax cutting agenda, also including a cut in the standard income tax rate to 19 per cent, will help to boost economic growth. “This is a new approach for a new era focused on growth,” the chancellor said. But if that growth does not appear then the economy will surely struggle to carry a much higher level of national debt, the financing costs of which will now steadily rise. The initial verdict of the markets suggests more turbulence now lies ahead — and soon.