Defiant Kwasi insists his plan will kickstart economy

Kwasi Kwarteng’s bold dash for growth could be blown off course by the financial markets’ adverse reaction to his tax-cutting Budget and the threat of imminent global recession, experts have warned.

The pound rose against the dollar yesterday after its fall to record lows on Monday when the Bank of England intervened to say that it would not hesitate to raise interest rates.

A weaker pound risks fuelling inflation, now at just under 10 per cent, because it makes imports dearer. But it is the rise in the cost of government debt that poses the biggest threat to the Chancellor’s radical plans to end years of sclerotic growth, economists say.

Yields on gilts – the interest paid on government IOUs – continue to hover close to their highest level for 12 years due to fears the Chancellor’s £45bn of tax cuts to kickstart growth will lead to a big increase in borrowing.

It prompted an intervention from the International Monetary Fund last night, which said: ‘We do not recommend large and untargeted fiscal packages at this juncture.

Julian Jessop, an independent economist, said: ‘The rise in bond yields is the bigger threat to the growth agenda than the fall in the pound, which is at least good for exporters. Higher bond yields are good for nobody, except perhaps the banks.

‘Borrowing costs will be higher across the whole economy, including on mortgage and corporate debt, as well as for the government.’

Some lenders have stopped offering new home loans because of increased market volatility.

But in a meeting with banks and other financial institutions yesterday, Kwarteng insisted his tax cuts package, to be funded by borrowing, would boost growth in the medium term.

‘We are confident in our long-term strategy to drive economic growth through tax cuts and supply side reform,’ he said. 

‘We have responded in the immediate term with an expansionary fiscal stance on energy because we had to. With two exogenous shocks – Covid-19 and Ukraine – we had to intervene.

‘Our 70-year high tax burden was also unsustainable.

‘I’m confident that with our growth plan and the upcoming medium-term fiscal plan, with close co-operation with the Bank, our approach will work.’

Despite attempts to calm markets, Bank of England governor Andrew Bailey remains under pressure to hold an emergency meeting of its rate-setting Monetary Policy Committee less than a week after hiking the cost of borrowing to 2.25 percent.

‘The key thing is, if you call it, you have to take significant action,’ said Professor Sir Charlie Bean, the Bank’s former deputy governor for monetary policy. ‘The lesson is you go big and you go fast.’

Markets forecast interest rates could hit 5 per cent per cent by the end of this year and 6 per cent next year.

Economists acknowledge Kwarteng’s tax cuts and energy bail-out plan will make any downturn shorter. ‘The combination of the energy levy and reversing planned tax hikes will prevent a deep recession that would have blown the public finances out of the water,’ said Gerard Lyons, of wealth adviser NetWealth, who is also an adviser to Prime Minister Liz Truss.

The Chancellor believes his measures to boost output will lead to annual growth of 2.5 per cent.

Nobody doubts this target is ambitious given the economy, hammered by Covid and the cost of living, is stagnant.

He is also faced with boosting growth amid global economic gloom. The World Bank recently warned leading central banks are in danger of sending the global economy into a ‘devastating’ recession next year if they raise costs of borrowing too much.

‘Central banks are scrambling to raise interest rates as inflation soars to the highest levels in almost two generations but they risk acting too forcefully,’ warned economist Maurice Obstfeld.

Germany, Europe’s largest economy, is ‘heading into a winter recession,’ says the Munich-based Ifo research institute. 

‘A eurozone recession is on the cards as companies report worsening business conditions and intensifying price pressures linked to soaring energy costs,’ 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 it could enter recession in the next 12 months.

In the UK, there are fears that attempts by the Bank of England to tackle inflation by hiking borrowing costs to 5 per cent or more could tip the country into a damaging recession. Bailey has been accused of being ‘asleep at the wheel’ by not raising rates sooner and faster.

The risk now is that he goes too far in the other direction.

Either way, if the governor and chancellor fail to win back trust of markets, borrowing costs are likely to go higher. In the meantime, the priority is to restore calm – and not before time.

‘Talk of ‘market meltdown’ and a ‘sterling crisis’ is overdone,’ said Jessop. ‘It may take more time to win over investors and the general public, but the most important thing is to get the economics right. This is a good start, despite the negative headlines.’