BIRMINGHAM, England (Reuters)
British Prime Minister Liz Truss was forced on Monday (October 3) into a humiliating U-turn after less than a month in power, reversing a cut to the highest rate of income tax that helped spark turmoil in financial markets and a rebellion in her party.
Finance minister Kwasi Kwarteng said the decision to scrap the top rate tax cut had been taken with “some humility and contrition”, after his party’s lawmakers reacted with alarm to a move that favoured the rich during an economic downturn.
We get it, and we have listened. pic.twitter.com/lOfwHTUo76— Kwasi Kwarteng (@KwasiKwarteng) October 3, 2022
Elected by party members but not the broader public, Truss and Kwarteng had sought to jolt the economy out of its more than 10-year run of stagnant growth with a 1980s-style plan to cut taxes and regulation, all funded by vast government borrowing.
Signalling a break with “Treasury orthodoxy”, they had also fired the most senior official in the government’s finance department and released the tax cut plan without accompanying forecasts on how much it would cost.
Investors – used to Britain being a pillar of the global financial community – were aghast. They sold British assets at such a rate that the pound hit a record low against the dollar and the cost of government borrowing soared, forcing the Bank of England to intervene to shore up markets.
“It is astonishing,” one Conservative lawmaker said, declining to be named. “The damage has already been done. We just look incompetent now, too.”
Another party insider said the Conservative government, in power under different leaders for 12 years but with Truss as prime minister only since September 6, was already on “survive a day at a time” mode as confidence and credibility drained away.
While the removal of the top rate of tax only made up around £2 billion out of the £45 billion of unfunded tax cuts, it was the most divisive element of a package that also stumped up tens of billions of pounds to subsidise energy costs.
HAPPY TO OWN IT
Less than a day after Truss went on BBC television to defend the policy, Kwarteng released a statement saying he now accepted it had become a distraction.
“We listened to people and yes there is some humility and contrition,” Kwarteng told BBC Radio. “And I’m happy to own it.”
He said he had not considered resigning.
The decision to reverse course is likely to put Truss and Kwarteng under even greater pressure, the latest threat to political stability in a country that has had four prime ministers in the last six years.
Asked if he should resign or be fired, one Conservative lawmaker said: “It’s very difficult, of course, because he’s only just been appointed. But my view is that he is significantly weakened.”
Truss and Kwarteng were elected into government in 2019 when former leader Boris Johnson secured a landslide victory on a very different manifesto, promising to increase government spending, particularly in Britain’s more deprived areas.
While defending the tax cut policy on Sunday, Truss had been unable to rule out that it would require cuts to spending on public services and restrictions on welfare payments in order to balance the books.
Many Conservatives warned that it risked taking them back to their “nasty party” image of 20 years ago.
Ben Houchen, the Conservative mayor of Tees Valley in northeast England, said he understood the idea of cutting taxes but said such a move during a cost-of-living crisis for millions had been “very naive”.
“Would I have done it? Absolutely not,” he told the party’s annual conference in Birmingham, where Kwarteng is due to speak later.
Britain’s opposition Labour Party said the government had destroyed its economic credibility and damaged the economy. “They need to reverse their whole economic, discredited trickle-down strategy,” Labour’s Rachel Reeves said in a statement.
While the pound has recovered from the depths of last week, British government bonds have mostly failed to recoup the historic losses incurred following Kwarteng’s “mini-budget” – with the exception of long-dated debt which is subject to Bank of England support.
Investors and economists said the reversal was a step in the right direction but the government needed to go further. It is not due to release a fiscal statement with the full scale of government borrowing and debt cutting plans until November 23.
“The issue was not tax changes announced at the mini-budget but the institutional ‘scorched earth policy’ that preceded it,” said Simon French, chief economist of brokerage Panmure Gordon. “UK risk premia will likely only pull back if that is addressed.”
Analysts said they were now having to weigh up the positive development that the government had been willing to reverse course, with the fact that its credibility has been damaged.
At the height of the market turmoil, the Bank of England was forced to intervene with a £65 billion (US$73 billion) programme to shore up markets that runs until October 14.
On the U-turn, Jane Foley, head of FX strategy at Rabobank, said the question remained of whether it was enough.
“The answer will be clear in a few weeks’ time when the Bank of England measures end,” she said. “UK assets, the pound and gilts are not out of the woods yet, and the British government has a lot to do to get back credibility.”