UK recession looms after Truss’ tax U-turn

Britain will be paying the price of Prime Minister Liz Truss and Mr Kwasi Kwarteng’s economic experiment for some time. PHOTO: REUTERS

LONDON - British Prime Minister Liz Truss promised growth and tax cuts, but the risks of recession are growing for Britain after her economic package backfired and forced the Treasury to raise taxes and weigh deep spending cuts.

The measures set out by Finance Minister Jeremy Hunt on Monday will pare £32 billion (S$51.6 billion) from the £45 billion of tax giveaways that Ms Truss’ government announced last month in a mini-budget that triggered a sharp sell-off in British assets. 

Support for energy bills will also be curtailed from April, causing fresh hardship for households and businesses that are already struggling with rising prices and interest rates.

The decision marks a massive U-Turn, with Mr Hunt ripping up Ms Truss’ “growth plan” in a desperate attempt to avert an economic calamity and salvage the government’s credibility. He replaced Mr Kwasi Kwarteng, whom the Premier sacked last Friday (Oct 14) when it became clear that investors would not stomach the mini-budget.

Britain will be paying the price of Ms Truss and Mr Kwarteng’s economic experiment for some time. Lost credibility shows up as a penalty on borrowing costs that Mr Dario Perkins, director of macro global at TS Lombard, calls the “moron risk premium”. 

The pound collapsed to a record low and government bond yields soared on fears that Mr Kwarteng’s debt-funded giveaways would send the national debt spiralling higher. This threatened to plunge Britain into “a severe downturn driven by a continued loss of market confidence”, said Mr Martin Beck, chief economic adviser to the EY Item Club.

While Mr Hunt’s emergency response may avoid the worst-case scenario, the economy will “still decline over the next few quarters”, Mr Beck added.

Mr Dan Hanson, senior British economist at Bloomberg Economics, said “the risks to our forecast for a 0.4 per cent drop in gross domestic product in 2023 have shifted to the downside”.

Mr Hunt also warned that spending cuts will be needed in the weeks ahead, signalling that a budget statement due Oct 31 will outline some of the more painful reductions. The Labour opposition said it amounted to “Austerity 2.0”.

The policy switch means the Treasury will no longer be working against the Bank of England (BOE) by adding to inflationary pressures. Mr Hunt wants to shore up investor confidence and put the public finances on a stable footing - demoting Ms Truss’ growth agenda. 

Addressing Parliament, Mr Hunt hinted at new fiscal rules that will ensure debt is falling as a share of national income and that, once the public finances are under control, there will be no borrowing to fund day-to-day spending. 

The outlook for the British economy has been deteriorating for weeks, with inflation near its highest in 40 years, sapping confidence and forcing consumers to tighten their belts. Goldman Sachs slashed its forecasts over the weekend, and a survey of economists by Bloomberg anticipates a recession starting this year followed by zero growth until late 2023.

Business groups welcomed the attempt to calm markets, but warned that Britain is now economically rudderless, with no long-term plan and a tax burden stuck at the highest in 70 years. 

British Chambers of Commerce director-general Shevaun Haviland warned that it is “a plan for today, and nothing for tomorrow”. She is concerned about the double impact of a surge in energy bills due to hit at about the same time that corporation tax will increase to 25 per cent from 19 per cent.

“This will be a hammer blow for many who were already worried about how they will survive,” Ms Haviland said.

Many households will pay higher electricity and natural gas bills starting in April after Mr Hunt said aid should be more carefully targeted.

Energy bills are now on track to rise to £4,000 next spring, according to independent British think-tank Resolution Foundation.

The government will maintain its freeze on energy bills at £2,500 through this winter as it reviews a new mechanism that will protect the public purse from volatility in global gas markets, but this will be adjusted from April. 

This means companies and households will “pick up more of the tab”, according to Capital Economics. The uncertainty about how much it will cost may mean inflation ending up “being higher for longer next year and that the recession is deeper as a result”.

Pressure is easing on the BOE to hike interest rates. While Ms Truss’ previous budget would have added to inflation, the impact of Mr Hunt’s decisions will be much more restrained. 

Investors are now betting that the BOE’s key rate will peak at 5.25 per cent, a full percentage point lower than fears in the middle of last month. Inflation at almost 10 per cent is still five times higher than the BOE’s 2 per cent target, but the Treasury’s lack of largesse is helpful to efforts to rein in prices.

Falling interest rates in financial markets also offered some respite. Ten-year government borrowing costs have dropped a half percentage point since the peak of the crisis, easing upward pressure on the cost of mortgages, and short-term rates have fallen a whole point. 

Office for Budget Responsibility data suggests that may reduce the Treasury’s annual debt interest bill by about £12 billion, an early win from Mr Hunt’s emergency plan that will take some pressure off the public finances. BLOOMBERG

Join ST's Telegram channel and get the latest breaking news delivered to you.