Pressure continued to mount on the UK on Wednesday, after the International Monetary Fund urged the government to reconsider its planned tax cuts on fears they will stoke inflation.
Chancellor Kwasi Kwarteng’s controversial mini-budget, unveiled on Friday, is centred around £45bn of tax cuts funded through further borrowing. The government intends to axe the top rate of tax, remove the cap on bankers’ bonuses, abandon a planned corporation tax rise, reverse a proposed increase to National Insurance and permanently raise the stamp duty threshold.
Markets plunged immediately after the statement, with the pound going on to reach lows against the dollar not seen since 1985. On Wednesday it had stabilised marginally, but remained under pressure, dropping to $1.06 after reaching $1.08 on Tuesday.
Meanwhile gilt yields, the interest paid on UK government debt, have soared as investors become less willing to hold sovereign debt. Yields on 10-year gilts have risen above 4%, the highest since the 2008 financial crisis, while the 30-year gilt yield breached 5% for the first time since 2002.
In response, the IMF – which is tasked with stabilising the global economy and traditionally tends to focus on emerging economies – said it was now “closely monitoring” developments in the UK and was “engaged with authorities”.
It believes that the “untargeted” proposals are likely to increase inequality, as well as adding to inflationary pressures, and urged the government to “re-evaluate” its plans.
“Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture,” it warned. “It is important that fiscal policy does not work at cross purposes to monetary policy.”
The sentiment was echoed by Moody’s, the credit ratings agency, which issued a highly critical note late on Tuesday, arguing that the tax cuts were credit negative.
It warned: “Large, unfunded tax cuts will lead to structurally higher deficits amid rising borrowing costs, a weaker growth outlook and acute public spending pressure stemming from the pandemic and a decade of austerity.
“A sustained confidence shock arising from market concerns around the credibility of the government’s fiscal strategy that resulted in structurally higher funding costs could also more permanently weaken the UK’s debt affordability.”
It concluded: “We expect higher borrowing, a larger debt burden and more persistent inflation over the medium term, which will likely lead to more aggressive policy tightening by the Bank of England, will lead to higher cost of funding for the UK sovereign.”
The government insists the tax cuts will help fuel growth and boost the economy, and argues that the strong dollar is hitting the pound.
In a note, Rabobank said: “The basic issue is that there has been an enormous loss of credibility of the UK government’s fiscal rectitude while at the same time fiscal policy will be working in direct opposition to monetary policy.
“We would suggest that this situation is not recoverable simply via BoE rate hikes. Instead, the only obvious path for stabilisation of the gilt market and the recovery of sterling is a leadership change at the top of the UK’s government.”
Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said: “The IMF’s move has added to worries that the UK is fast taking on the characteristics of an emerging market economy, and risks ditching its developed country status. It’s not only wracked with trade disputes, an energy crisis, soaring inflation but is being closely monitored by the world’s lender of last resort.
“Expectations that there will be a super-size interest rate hike coming from the BoE to try and counter the government splurge on tax cuts and spending have increased.”
