One of the world’s leading multilateral financial institutions has joined a chorus of criticism of huge tax cuts announced by the UK government last week that sent the pound plunging to a record low.
In a rare and stinging rebuke for such a large developed economy, the International Monetary Fund warned that the tax cuts — the biggest in Britain since the early 1970s — would likely increase inflation and inequality.
“We understand that the sizable fiscal package announced aims at helping families and businesses deal with the energy shock and at boosting growth via tax cuts and supply measures,” an IMF spokesperson said.
“However, given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy,” the spokesperson added.
The collapse in the pound since Friday has been accompanied by an eye-watering surge in UK borrowing costs, with yields on 5-year government bonds now topping those of much more heavily-indebted European economies such as Italy and Greece.
Financial markets are now expecting the Bank of England to have to raise rates to near 6% by next spring, from 2.25% at present, to shore up the currency and contain the inflationary pressures unleashed by the huge fiscal giveaway. The central bank’s chief economist on Tuesday promised “significant” rate action at its next meeting in November.
The Bank of England on Wednesday announced an emergency intervention in the government bond market, pointing to recent “dysfunction.” It said it would buy long-dated UK government bonds on “whatever scale is necessary” to “restore orderly market conditions.”
The government of Liz Truss, who succeeded Boris Johnson as prime minister only three weeks ago, said Friday that it would cut taxes by £45 billion ($48 billion) in a bid to get the UK economy moving again. The package includes scrapping the highest rate of income tax for top earners and a big increase in government borrowing to slash energy prices for millions of households and businesses this winter.
But many leading economists have described the unorthodox measures as a reckless gamble, and have warned that they will force the Bank of England to slam on the brakes even harder as it tries to tame inflation that is already running near 40-year highs at almost 10%.
The UK Treasury has tried to calm market nerves by saying it will provide more details of its plans on November 23 and is committed to ensuring that debt falls as a share of UK GDP in the medium term.
The IMF said the planned measures would “likely increase inequality,” and it called on the UK government to use the budget in November as an opportunity “to consider ways to provide support that is more targeted and reevaluate the tax measures, especially those that benefit high-income earners.”
But that may come too late for businesses, which are already facing a sharp rise in borrowing costs, and hundreds of thousands of mortgage holders who will need to refinance their loans in the last quarter of this year. Hundreds of mortgage products have already been pulled from the market as banks struggle to keep pace with bond market volatility.
Yields on 10-year UK government bonds fell sharply after the Bank of England’s announcement on Wednesday but remain elevated. They were last near 4.1%, up from under 2.9% at the beginning of the month. The pound continued its decline, however, sliding 0.4% to below $1.07.
‘Really stupid’
Charlie Bean, former deputy governor of the Bank of England, told CNN Business that the UK government was guilty of “really stupid” decisions, and he described the IMF intervention as “striking.”
“It’s unusual for the IMF to do that, particularly for a G7 economy, and for them to do it so swiftly,” he said. “They might do these sorts of things for an emerging market country that has been on the edge for a while.”
The IMF has history in Britain. The last time a UK government cut taxes this much, there was rampant inflation, a massive jump in debt and eventually an IMF bailout in 1976. Things aren’t that bad, yet.
“This is not 1976 where we have a currency crisis, a balance of payments crisis, and we go to the IMF cup in hand asking for an emergency loan. But this is a situation where government borrowing costs … are incredibly vulnerable,” Mohammed El-Erian, president of Queens’ College at Cambridge University and an adviser to Allianz, told the BBC on Tuesday.
Ratings agency Moody’s slammed the British government’s plans.
“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,” it said in a note on Tuesday, adding that the loss of confidence among investors in the government could “permanently weaken the UK’s debt affordability.”
— Julia Horowitz and Anna Cooban contributed to this article.
