There and back again: How will Chancellor Jeremy Hunt’s plan affect the economy?
The ‘mini-budget’ U-turn
Following the ‘mini-budget’ in September, we’ve seen a significant shake up in UK markets. The impact of this has meant that much of what was announced in September has now been undone.
Former Chancellor Kwasi Kwarteng’s mini-budget included tax cuts across the board in a bid to stimulate the UK economy. With the Bank of England (BoE) trying to control climbing inflation at the same time, the news was met with sell-offs in the gilt market and a plummeting sterling. Kwarteng was eventually replaced as Chancellor by Jeremy Hunt and most of the proposed tax cuts were dropped.
A CHANGE IN DIRECTION
‘Trussonomics’ advocated that tax cuts would pay for themselves by stimulating growth. This has now been replaced by a policy that tax cuts don’t provide sufficient benefits versus the deteriorating public finances they cause. As a result, in terms of fiscal measures, only the energy price freeze remains to help support economic demand. But Hunt says this will only be in place now for six months, rather than the initial two years.
Despite reversing most of the tax cuts, the government still has the challenge of cutting back public spending by roughly £30-40 billion a year. This is to counteract the Office for Budget Responsibility’s estimate that puts the initial budget deficit at nearly £70 billion. Achieving this could cause political volatility as it remains unclear how united the Conservative party will be behind a new fiscal plan with substantial spending cuts. The outlook for UK assets therefore remains uncertain even as the government reverses course.
Where will interest rates go?
This all has implications for the future path of interest rates. Reversing tax cuts and scaling back on government spending should lead to weaker economic growth, which could mean lower interest rates in 2023 than previously expected. Markets have already adjusted down their estimates for interest rates. They now think they will reach around 5% instead of almost 6%.
The BoE will still likely implement large interest rate hikes in the next two months, however, as it looks to find a balance between the government’s plan for financial stability and the soaring cost-of-living. Also, the potential for the energy prize freeze to end in April next year carries the risk that inflation numbers may not fall back in 2023 as projected.