Defiant Kwasi insists he will kickstart economy

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Experts warn that Kwasi Kwarteng’s bold pursuit of growth could be thwarted by a backlash from financial markets against his tax-cutting budget and the threat of an imminent global recession.

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The pound rose against the dollar yesterday after falling to a record low on Monday when the Bank of England stepped in, saying it would raise interest rates without hesitation.

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A weaker pound risks fueling inflation, which is now just under 10%, as imports become more expensive. But it is the rise in the cost of public debt that poses the greatest threat to the Chancellor’s radical plans to reverse years of sclerotic growth, economists say.

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Gamble: The chancellor believes his measures to increase production will lead to annual growth of 2.5%.

Securities yields – the interest paid on government IOUs – continue to hover near the highest level in 12 years due to fears that the £45bn tax cut proposed by the chancellor to kick-start growth will lead to a significant increase in borrowing.

This prompted an intervention by the International Monetary Fund last night saying, “We do not recommend large and untargeted fiscal packages at this stage.”

Julian Jessop, an independent economist, said: “A rise in bond yields is a bigger threat to the growth agenda than a fall in the pound, which is at least good for exporters.” Nobody needs higher yields on bonds, except, perhaps, banks.

“The cost of borrowing will be higher for the entire economy, including mortgage and corporate debt, as well as for the government.”

Some lenders have stopped offering new home loans due to increased market volatility.

But yesterday, in a meeting with banks and other financial institutions, Kwarteng insisted that his debt-financed tax cut package would boost growth over the medium term.

“We are confident in our long-term strategy to stimulate economic growth through tax cuts and supply reform,” he said.

“We have reacted in the near term with an expansionary fiscal stance on energy because we were forced to. With two exogenous shocks — Covid-19 and Ukraine — we had to intervene.

“Our 70-year high tax burden has also been unbearable.

“I am confident that with our growth plan and forthcoming medium-term financial plan, in close collaboration with the Bank, our approach will work.”

Despite attempts to calm the markets, Bank of England Governor Andrew Bailey is still forced to hold an emergency meeting of his monetary policy committee less than a week after borrowing costs rose to 2.25%.

“The key is that if you call it that, you have to take serious action,” said Professor Sir Charlie Bean, a former deputy bank governor for monetary policy. “The lesson is that you go big and you go fast.”

Markets predict that interest rates could reach 5% by the end of this year and 6% next year.

Economists concede that Kwarteng’s plan to cut taxes and bail out energy would make any recession shorter. “The combination of the energy levy and the cancellation of the planned tax increase will prevent a deep recession that would blow public finances out of the water,” said Gerard Lyons, wealth adviser at NetWealth, who is also an adviser to Prime Minister Liz Truss.

The chancellor believes that his measures to increase production will lead to annual growth of 2.5%.

No one doubts the ambition of this goal, given that the economy, hit by Covid and the cost of living, is stagnating.

It has also faced accelerated growth amid global economic gloom. The World Bank recently warned that leading central banks risk sending the global economy into a “destructive” recession next year if they raise borrowing costs too much.

“Central banks are scrambling to raise interest rates as inflation soars to its highest level in nearly two generations, but they risk acting too harshly,” warned economist Maurice Obstfeld.

Germany, Europe’s largest economy, is “looming for a winter recession,” according to Munich-based Ifo research institute.

“A recession in the eurozone is on the horizon as companies report worsening business conditions and increased price pressures associated with higher energy prices,” said Chris Williamson of S&P Global Market Intelligence.

Even the US, the world’s largest economy, is vulnerable. More than half of economists recently said that a recession could begin in the next 12 months.

In the UK, there are fears that attempts by the Bank of England to cope with inflation by raising the cost of borrowing to 5% or more could lead to a devastating recession in the country. Bailey has been accused of “falling asleep at the wheel” by not raising the stakes faster and faster.

Now the risk is that he will go too far in the other direction.

In any case, if the governor and chancellor fail to regain market confidence, the cost of borrowing is likely to rise. In the meantime, the priority is to restore calm – and not ahead of time.

“The talk of a ‘market crash’ and a ‘sterling crisis’ is overblown,” Jessop said. “It may take longer to win over investors and the general public, but the most important thing is getting the economy right. It’s a good start, despite the negative headlines.”

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