By Geoffrey Smith
Investing.com — U.K. government bonds extended their rally in London trading on Monday after the government's new finance chief scrapped almost all of Prime Minister Liz Truss's ill-fated tax cuts and also flagged a quicker end to Truss's promised energy subsidies.
By 07:45 ET (11:45 GMT), the yield on the benchmark 10-Year government bond, or Gilt, was down a whopping 36 basis points at 3.96%, just off its intraday low of 3.92%, as bond investors moved to dismantle the risk premium they had built into Gilts in alarm at Truss's original plans. The 30-Year yield tumbled 40 basis points to 4.38%, while the 2-Year yield fell 38 basis points to 3.50%.
The pound also recovered further, rising over 1.5% against the dollar and 0.9% against the euro on relief that the government will no longer pursue a course that was almost universally condemned as unsustainable – even within the ranks of the ruling Conservative Party.
Jeremy Hunt, who took over from Kwasi Kwarteng on Friday as Chancellor of the Exchequer, told reporters in Downing Street that the basic rate of income tax will remain at 20% instead of being cut to 19%, while Kwarteng's plans to cut taxes on dividends, freeze duty on cigarettes and alcohol, and loosen regulations relating to self-employed contractors will also be scrapped.
Just as importantly, Hunt said that Truss's previous promise to cap energy bills for most households for two years would be reviewed instead already in April 2023, amid fears that it – like the planned tax cuts – could not ultimately be paid for.
Hunt's announcement completed a remarkable 'round trip' for British policy over the last month. Liz Truss had become Prime Minister with a promise to slash taxes, improve the conditions for investment and return to the small-state roots of Margaret Thatcher's Conservative governments of the 1980s. However, financial markets judged that such stimulus would only drive inflation higher, given the lack of slack in the U.K. labor market, the ongoing inflationary shock coming through the energy markets, and the damage to the U.K. economy's growth potential due to Brexit.
The violent rise in government bond yields, which also caused the mortgage market to seize up, quickly made Truss's plans to kickstart growth via higher short-term borrowing impractical.
"These radical policy reversals on tax and energy bill support by Jeremy Hunt show that the priority now is to reduce pressure on the Bank of England to raise interest rates, which it would otherwise need to do to counter the Government’s fiscal boost’s upward pressure on inflation," said Torsten Bell, director of the Resolution Foundation think-tank.
Bank of England Governor Andrew Bailey had warned on Friday that the events of the last month made a more aggressive tightening of monetary policy more likely.
"As things stand today, my best guess is that inflationary pressures will require a somewhat stronger response than what we thought in August," Bailey had told an event on the sidelines of the International Monetary Fund's autumn meeting.
Bell noted that as a result of the changes announced on Monday, tax as a share of national income is now set to rise to its highest level since 1951.
However, one key element of the original Truss/Kwarteng package remained: Hunt indicated that he won't reinstate the increase in national insurance contributions that Kwarteng had announced in September. The increase had been intended to create ring-fenced funding for social care. The spending commitment, however, remains in force.
Tweaks made by Kwarteng to stamp duty, the transaction tax on house purchases, will also remain.
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