Despite buying some time, the fate of this government is still in the hands of the markets, says City's Honorary Research Fellow Professor Steve Schifferes
Newly installed UK chancellor, Jeremy Hunt, has unveiled a raft of changes to Kwasi Kwarteng’s September 23 mini-budget, which essentially amounted to a rollback on most of its headline points.
The September mini-budget, which included £45 billion in unfunded tax cuts, created significant volatility in financial markets in the weeks after it was announced. The resulting impact on the cost of borrowing for the UK also filtered through to consumer mortgage rates and pensions.
Hunt has indefinitely postponed a planned cut to the basic rate of income tax and rolled back most of the other taxation plans from the government’s growth plan. Only the repeal of the National Insurance increase and the cut to stamp duty remains because they are already in the process of being signed off by parliament.
Financial market reaction
"The government appears to have stabilised the financial markets with an emergency statement by the new chancellor, Jeremy Hunt. The statement was brought forward by two weeks, in an unprecedented move designed to calm recent financial market turbulence in the weeks following ex-chancellor Kwasi Kwarteng’s September 23 mini-budget.
The interest rate on a key measure of government debt, 30-year gilts, had been rising sharply over the weekend to 4.8%, but fell back to 4.4% immediately ahead of Hunt’s statement. Such drops are uncommon in this market, which has now stablised. The cost of government borrowing has still not recovered to the 3.5% level of before the mini-budget, however. Similarly, the pound strengthened from $1.11 to $1.13, but remains 18% below its level one year ago.
In addition to scrapping £32 billion of the £45 billion in unfunded tax cuts announced in the mini-budget, Hunt also announced there would be further public spending cuts. Most importantly, however, the government has abandoned its commitment to fund an energy price cap – expected to cost £60 billion this year alone – beyond April 2023.
It will replace the scheme with a more targeted measure to be developed by the Treasury in the meantime. This will substantially reduce the deficit for the next two financial years – the original time period for the plan, announced in September. This will not have a direct impact on the Office of Budget Responsibility’s five-year deficit forecast, which discounts temporary measures, but it will lower the amount of debt interest payments the government will have to make.
But there are limits to how far his announcement can completely reassure the markets. Investors are likely to continue to add a “risk premium” when it comes to the UK, which means the markets will still demand higher interest rates when lending to the UK government than before the mini-budget. Among other issues, concerns remain over political instability, with the fate of the prime minister Liz Truss, in particular, remaining unclear.
Additionally, the increased likelihood of a UK recession (which would reduce government revenues) has increased. This is partly because the Bank of England is now expected to raise interest rates more sharply than previously planned, and also because the global economy – especially in the US, Europe and China – is slowing down faster than anticipated.
The next test for the government will be the Office for Budget Responsibility forecast and full budget statement on October 31. Despite buying some time, the fate of this government is still in the hands of the markets."