Kwarteng’s ‘seismic’ Growth Plan is a bold set of measures - with risks

The new Chancellor Kwasi Kwarteng heralded ‘a new approach for a new era’ as he presented the Truss government’s extensive tax-cutting fiscal plans today. 

The headline announcements in Kwarteng’s ‘mini-Budget’ were: 

• 45p income tax rate paid by those earning more than £150,000 abolished from April 2023
• 1p cut to basic rate of income tax brought forward by a year to April 2023
• No stamp duty to be paid on property purchases up to £250,000 and up to £425,000 for first-time buyers
• Hike in National Insurance contributions to be cancelled from 6th November – retaining higher July threshold
• Reversing the 1.25% dividend tax hikes from next April
• Cancellation of next year's planned rise in the main rate of Corporation Tax so the levy will remain at 19 per cent

‘While a number of measures had been well trailed in advance, it’s fair to say the seismic move to abolish the additional 45 per cent tax rate was totally unexpected,’ says Jason Hollands, Managing Director at investing platform Bestinvest. ‘Together with the fast-tracking of the 1p basic rate cut and a range of other cuts to direct and indirect taxation, the Chancellor has announced a fiscal boost of £45 billion, according to the Treasury’s own numbers. This is undoubtedly a huge role of the dice.’ 

He adds: ‘That goes go alongside the huge commitment to cap energy bills for homes and businesses that he revealed today will amount to £60 billion in the first six months.  

‘Coming a day after the Bank of England hiked its benchmark interest rate at the seventh consecutive monetary policy meeting, the Chancellor’s statement highlights how fiscal and monetary policies are now pulling in opposite directions.’ 

The Bank of England pushed up interest rates by 0.5 percentage points to 2.25 per cent yesterday, the highest level since 2008, with three monetary policy committee member voting for a larger hike of 0.75 that could still arrive in November, alongside what will be a hotly anticipated new set of economic forecasts from the Bank. 

Hollands says the major fiscal boost to the economy might extend the BoE’s battle to tame inflation: ‘We have a situation where rate setters are tapping on the economic brakes with increasing ferocity, at the same the UK Government has decided to put its foot hard on the accelerator. Higher interest rates will drag on the growth boost that the Chancellor is obviously hoping will result from the tax cuts.’ 

He adds: ‘Fiscal expansion of this scale is certainly bold, but also risky, not least because the shortfall on the public finances will be funded through borrowing at a time when costs of borrowing are rising.’ 

UK bond yields, which have risen sharply this year, soared further after Kwarteng’s speech: two-year gilt yields hit a new high since October 2008 and were last up 47 basis points in the biggest daily jump since November 2009. Five-year yields, sensitive to economic policy expectations, rose to a similar high and were up 47 bps in the biggest daily rise since 1991.  

Ten-year gilts were yielding 3.8% by late morning, up from 0.8% a year ago.  

‘A key potential downside is if the markets become concerned about the sustainability of the UK public finances,’ says Hollands. ‘Failure to convince could drive Sterling lower, having already plunged to levels against the Dollar last seen in 1985.’  Sterling fell below $1.11 today. 

‘The scrapping of corporation tax rises and effect of reversing the National Insurance increases will be particularly welcome news to hard-pressed domestically focused businesses,’ says Hollands.   

'With so much negativity priced into domestically focused companies – which tend to be in the mid and small cap space - contrarians may be tempted to invest in them now given this helpful news on tax and energy costs in recent days. But for now, this should be regarded as pain relief rather than a cure. The prospect of a very deep recession has faded a little, but the UK domestic economy is still facing a challenging period, as highlighted by the BoE this week.   

‘When it comes to the largest UK companies however, these have relatively low exposure to the domestic economy and high weightings to sectors that have in the past  proven resilient in times of high inflation and struggling growth - energy, healthcare and consumer staples.   

‘Moreover, in aggregate, around three quarters of revenues of FTSE 100 companies are made outside of the UK, much of which is in US Dollars. In the near term, as overseas earnings are translated back into Sterling reported profits and dividends this should be supportive.  

‘Valuations of UK blue-chip equities also look attractive overall both compared to other developed markets and their own long-term trend. They also provide a relatively attractive dividend yield of c. 4%, which is more than double the dividend yield of global equities.  

‘Many private investors have shunned UK large cap equities for several years, as the market has lacked the excitement of a meaningful growth sectors like tech and communication services and the drawn-out Brexit saga cast a long shadow, but we are in different times now. As the days of ultra-low borrowing costs and vast money printing have been eclipsed by high inflation and rising borrowing costs, it could be wise to take a fresh look.’    

On household finances and stamp duty, Alice Haine, Personal Finance Analyst at Bestinvest, adds:  

‘Chancellor Kwasi Kwarteng’s shake-up of the UK’s tax system delivered a host of major changes for household finances with one of the most significant the cut in the basic rate of income tax by 1p in the pound from April 23 – delivering an average £170 reduction in tax.  

‘The reversal of the 1.25% increase in National Insurance will also save 28 million workers an average of £330 a year. However, like the surprise decision to abolish the 45% additional rate of tax, paid to those who earn more than £150,000 a year, from April 2023, the impact of the NI reduction will benefit higher earners more.  

‘With the new threshold on when NI kicks in, introduced by former Chancellor Rishi Sunak in July this year, remaining at £12,570, someone earning £15,000 will receive a monthly boost of just £2.50 to their pay packet – or £30 a year - from November compared to now. A worker earning £20,000 will receive £7.75 extra in their take-home pay or £93 a year and jump to an income of £50,000 and the annual saving of £468 equates to a monthly income boost of £39.   

‘Employees on salaries of £100,000 save £1,093 a year or £91.08 a month in NIC with the biggest gains going to those earning more than £150,000 who save £1,718 over a 12-month period - the equivalent £143.16 a month.  

‘In this era of stagnant economic output and falling real wages, the government’s high growth agenda seeks to steer the country away from a long, drawn-out recession. While any increase in take-home pay is a bonus for households contending with soaring food and energy bills, it may be hard for those on lower incomes to accept such a little uplift in the short term when higher earners appear to be receiving more.  

‘They need to look forward to April next year when the basic rate of income tax – paid by all workers earning between £12,571 and £50,270 - will be cut by 1p in the pound delivering a boost of £170 on average. Lower earners must also remember that energy bills could have been much higher had the Prime Minister not stepped in with her energy plan to freeze utility bills at £2,500 for the typical household for the next two years – preventing a very challenging time for many over the winter months – with the Government also dishing out cost-of-living handouts to the most vulnerable.  

‘The real winners in this budget, however, are first-time buyers looking to get onto the property ladder who will now have no stamp duty to pay on the first £425,000, up from the previous level of £300,000. First-time buyers will be able to benefit from this higher nil-rate band on homes up to the value of £625,000 – a significant increase from the previous cap of £500,000 – saving a huge chunk of cash at a time when affordability was becoming a real challenge.  

‘With the change coming in immediately, it means even buyers that complete purchases today should benefit. For all other buyers, the zero-rate stamp duty band was lifted to £250,000 in England and Northern Ireland, double the previous £125,000 – giving the property market a mini-boost at a time when house prices were at record highs and rapidly rising interest rates had the potential to quell demand for homes.’