Explained | Britain’s week of market turmoil and the tax cut reversal

The pound slumped to its lowest point against the dollar accompanied by skyrocketing bond yields, triggering an emergency intervention by the Bank of England and a tax reversal by the UK PM

The story so far: On Monday, October 3, recently elected United Kingdom Prime Minister Liz Truss was forced to reverse plans to bring in Britain’s highest tax cuts in 50 years, after a “minibudget” presented by her Finance Minister Kwasi Kwarteng set in motion a tumultuous week for the country’s markets. Announcing the reversal and acknowledging that the budget plan had become a “distraction” from the new government’s mission to “tackle the challenges” facing the U.K., Mr. Kwarteng said: “We get it, and we have listened.”

Notably, the International Monetary Fund (IMF) rebuked the government’s new tax plans last week, cautioning that they were likely to increase inequality and drive up inflation. The most immediate reaction to the plans was the plummeting of the pound to record lows and the increase in the government’s cost of borrowing to record highs, prompting an emergency intervention by the Bank of England.

Monday’s tax cut reversal announcement helped the pound sterling bounce back against the dollar. It was up 1.4% to the highest level since before the minibudget was announced.

On September 23, Kwasi Kwarteng, the U.K.’s Chancellor of the Exchequer (Finance Minister), in a “minibudget” statement announced the country’s biggest tax cuts in 50 years, worth £45 billion ($48.7 billion; €50.3 billion along with additional massive spending to “boost economic growth and generate increased revenue”. This was in addition to previously announced plans worth more than60 billion pounds to cap soaring energy bills for homes and businesses.

The problem, however, was that the announced plans were unfunded, or to be funded by further borrowing. When governments usually announce tax cuts to boost the economy, corresponding government spending reductions are also announced to ensure that borrowing does not spike, but instead, Mr. Kwarteng’s plan called for huge additional spending fueled by borrowing.

While inflation was already at record highs, the borrowing-heavy plan triggered a crisis of confidence in the government, with markets and investors worried that the tax cuts would drive up inflation and force the Bank of England to increase its interest rates at a faster pace. Investor mistrust further deepened since the plans were not accompanied by a forecast or assessment from the U.K.’s budget watchdog Office for Budget Responsibility (OBR). Moreover, in concurrence with the IMF, the British think-tank Resolution Foundation also said that the tax cut would unjustly benefit the richest Brittons.

After the minibudget on September 23, the pound plunged over 3% and two days later, briefly dipped as low as $1.0349 per U.S. dollar before rebounding to $1.0671. The British currency was trading at levels last seen in the early 1980s.