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Analytics, 15 October 2022

UK minister of finance sacked; Sterling tumbles

UK markets were on a volatile trade on Friday, 14th Cctober, after British Prime Minister Liz Truss on Friday dismissed her finance minister, Kwasi Kwarteng, after he announced controversial spending plans that triggered economic turmoil.

The British prime minister was dismissed in person by Truss after he rushed back early from international meetings in Washington, multiple media reports said, and she was due later to hold her first Downing Street news conference.

This sacking was perhaps to ease the pressure, following Kwarteng and Truss’ announcement of 20 billion pounds ($22 billion) of unfunded tax cuts, which drove the british pound to a record low vs the dollar, with investors expressing fear the state would plung into unsustainable debt.

Following the announcement, the sterling sank 1.1 percent to $1.119. British gorvernment bonds, known as gilts — rallied sharply ahead of the news conference. The long-dated 30-year yield briefly touched 4.261% during morning trade.

Kwarteng’s controversial tax cut bill

The British prime minister first came under fire on Friday, 23rd September, when he announced that the United Kingdom would implement the most significant tax cuts in 50 years while boosting government borrowing and spending in the face of high inflation. This would include abolishing the 45 percent tax rate on incomes over 150,000 pounds.

These tax cuts alongside a plan to support households in dealing with their rising energy bills would require the British government to borrow an extra 72 billion pounds in the next six months alone.

This drove the British pound lower, with the sterling losing 3.6% following the announcement last month. Investors were particularly concerned about the UK’s ability to manage so much extra debt, especially as rising interest rates make borrowing much more costly.

Three weeks following the announcement, the Pound has continued to plunge further against the USD as investors dump the GBP for its USD counterpart, leaving the UK and the wider Eurozone in a tight economic situation as both are widely thought to be in recession.

Events leading to the sacking

Following the tax cuts announcement last month, the British pound continued to plunge as bond yields rose until the Bank of England (BOE) said it would step in to prop up the gilt market by buying as many long-dated government bonds as needed between now and October 14th to stabilize financial markets. Prices in the UK gilt market rose following the intervention announcement, indicating a positive uptake of the news by the market.

The BOE has continued buying UK government bonds and on Tuesday announced an extension of its emergency bond-buying operation as the pound fell and borrowing costs soared. The bank also remains adamant on whether it will stop its intervention yet.

These interventions have done little to calm the situation in the UK, and the Conservative government has faced growing political pressure to reverse course on the unfunded tax cuts. Opinion polls show support for Truss’ administration has collapsed and investors continue to fret about the potential impact on public finances. This has led Truss to change her mind about cutting income tax for the highest earners and it is widely speculated that she would also change her mind on planned changes to corporation tax to ease the pressure on her government.

Truss went on and announced to the lawmakers in the House of Commons that she would not be making cuts to public spending to help pay for the government’s tax cuts. All these moves however have not been able to calm the UK markets, and Sunak, Truss’ opposition during the appointment of Johnson’s successor, continues to be vindicated by his remarks that higher borrowing to pay for tax cuts served only to terrify the markets and drive up borrowing costs for millions of Britons.

Market reaction following the announcement

Following the announcement, the sterling sank 1.1 percent to $1.119. British government bonds, known as gilts, rallied sharply ahead of the news conference. The long-dated 30-year yield briefly touched 4.261% during morning trade. Two-year gilt prices, which turned lower before Truss spoke, dropped further in late trade, pushing the yield up 18 basis points to 3.97%.

The blue-chip FTSE 100 index gave up almost all the day’s gains to close just 0.1% higher.

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