Business
Pound sinks as investors question huge tax cut
The pound has fallen to a fresh 37-year low against the dollar as financial markets reacted to the biggest tax cutting moves in 50 years.
UK stocks also dropped after chancellor Kwasi Kwarteng outlined a series of tax cuts and economic measures in a massive shake-up of the country’s finances.
The pound fell more than 3% against the dollar, dropping below $1.09.
Sterling has fallen recently over worries about the economy and partly due to a stronger US dollar.
The pound also fell more than 1% against the euro on Friday, dropping to €1.12.
Mr Kwarteng refused to comment on the dropping value of the currency, saying he “doesn’t comment on market movements”.
The cost of government borrowing soared following the announcement, rising by near-record amounts, as investors did the sums over the new strategy.
According to Bloomberg data, analysts expect UK interest rates to hit 5.2% in August 2023, with expectations rising that there could be a one percentage point interest rate hike at the Bank of England’s next meeting in November.
The Institute for Fiscal Studies (IFS), an economic think tank, said the market reaction was “worrying” as the government’s new strategy relied on investors being willing to lend more to the UK.
“The plan seems to be to borrow large sums at increasingly expensive rates, put government debt on an unsustainable rising path, and hope that we get better growth,” said IFS director Paul Johnson.
Mr Johnson said the new strategy would inject demand into a high inflation economy, risking further price rises. At the same time the Bank of England was pulling in the opposite direction, and was likely to raise interest rates even further in response to the £45bn tax reduction.
The Bank of England needs to make an emergency, unscheduled rate hike as soon as next week “to regain credibility with the market”, said Deutsche Bank strategist George Saravelos.
He said that move would also send a strong signal that the bank is “willing to do ‘whatever it takes’ to bring inflation down quickly”.
Former US Treasury secretary Larry Summers warned the pound could fall below the dollar due to the huge spending commitments outlined by Mr Kwarteng.
“It makes me very sorry to say, but I think the UK is behaving a bit like an emerging market turning itself into a submerging market,” Mr Summers told Bloomberg.
“Between Brexit, how far the Bank of England got behind the curve and now these fiscal policies, I think Britain will be remembered for having pursuing the worst macroeconomic policies of any major country in a long time.”
Jane Foley, a currency strategist at Rabobank, said the sell-off of sterling showed investors have doubts about the government’s plans.
“They’re worried that some of these tax cuts that have been announced aren’t going to be fully funded. That will result in a large amount of debt at a time when the Bank of England is going to be selling some of its holdings of UK government debt,” she said.
“I think this government does need to provide a lot more reassurance that it does have fiscal sensibility in order. This is not the message that’s come across this morning.”
The UK’s FTSE 100 index of major shares fell more than 2%, dropping to its lowest level for more than two months, reflecting concerns that the plan to stimulate growth might not pay off.
The plan also contributed to a sell-off in US markets, where the three main share indexes fell more than 2%.
“Ultimately, the growth dice have been rolled. But it is too early to know if the gamble will succeed and boost confidence enough to encourage businesses and people to spend and invest, stimulating the UK economy,” said Karen Campbell-Williams, head of tax at Grant Thornton.
Thomas Pugh, economist at RSM UK said there was likely to be a boost to the economy of “roughly 1%” over the next year, reducing the risk of a longer recession, but that the longer term outlook was less positive.
“There was nothing in the budget that makes us more optimistic about the long-term growth trend of the economy. Trend growth is currently probably half of the 2.5% the Chancellor has set as his new target,” he said.
And while it should initially soothe some of the recession we are already likely in, the similarly huge borrowing has sent markets reeling.
It has been one of the worst days for UK Government bonds in decades, with some of biggest one-day hikes in the cost of borrowing since the 1990s.
This has consequences not just for government, but it sets the basis for long-term borrowing rates for companies and householders.
The lack of numbers, visibility, and quantifiable commitment to reining in government borrowing has added to uncertainty in markets.
The government had to tell the markets that it needed to borrow an extra £72bn this year, but did not publish the numbers behind that. Interest rates charged for British debt hit 4%, having been 3.1% earlier this week, and 1.8% at the beginning of the leadership contest with Rishi Sunak.
The Treasury’s answer to all this is a table of forecasts which shows how much tax revenue would be raised if its reforms were able to permanently raise growth in the economy.
But that table, while an aspiration that every chancellor and every politician seeks, has not convinced the markets. It is an assumption of extra tax revenue that has replaced actual tax.
The prime minister criticised bean counters in her leadership campaign. Today’s plan only shows one side of the ledger. For a chancellor making a debut, it is usual to focus on fiscal credibility. That was not the priority here.
Reports /TrainViral/
The prospective new owner of Royal Mail has said he will not walk away from the requirement to deliver letters throughout the UK six days a week, as long as he is running the service.
“As long as I’m alive, I completely exclude this,” Czech billionaire Daniel Kretinsky told the BBC.
Mr Kretinsky has had a £3.6bn offer for Royal Mail accepted by its board.
Shareholders are expected to approve the deal in the coming months, but the government also has a say over whether it goes ahead.
Currently the Universal Service Obligation (USO) requires Royal Mail to deliver letters six days a week throughout the country for the same price. But questions have been raised over whether the service could be reduced in the future.
In an exclusive interview with the BBC, Mr Kretinsky also said he would be willing to share profits with employees, if given the go-ahead to buy the group.
However, he appeared to reject the idea of employees having a stake in Royal Mail, which unions have called for in exchange for their support.
The Royal Mail board agreed a £3.6bn takeover offer from Mr Kretinsky in May for the 500-year-old organisation, which employs more than 150,000 people. Including assumed debts, the offer is worth £5bn.
But because Royal Mail is a nationally important company, the government has the power to scrutinise and potentially block the deal.
As well as keeping the new government on side, Mr Kretinsky also faces the task of convincing postal unions that the proposed deal will benefit employees.
The USO is a potential sticking point for both the government and unions.
Royal Mail is required by law to deliver letters six days a week and parcels five days a week to every address in the UK for a fixed price.
How well this has actually been working in practice is a different matter. Ten years ago, 92% of first class post arrived on time. By the end of last year it was down to 74%, according to the regulator Ofcom.
Last year the regulator fined Royal Mail £5.6m for failing to meet its delivery targets.
Royal Mail has been pushing for this obligation to be watered down. It wants to cut second class letter deliveries to every other weekday, saying this will save £300m, and lead to “fewer than 1,000” voluntary redundancies.
‘Unconditional commitment’
Mr Kretinsky has committed in writing to honouring the USO, but only for five years.
And after that, in theory, the new owners could just walk away from it.
However, Mr Kretinsky told the BBC: “As long as I’m alive, I completely exclude this, and I’m sure that anybody that would be my successor would absolutely understand this.
“I say this as an absolutely clear, unconditional commitment: Royal Mail is going to be the provider of Universal Service Obligation in the UK, I would say forever, as long as the service is going to be needed, and as long as we are going to be around.”
Mr Kretinsky added that the written five-year commitment was “the longest commitment that has ever been offered in a situation like this”.
Another potential stumbling block for the deal, however, is how the company will be structured.
Unions would like to see the company renationalised, but Dave Ward, general secretary of the Communication Workers Union (CWU), told the BBC that would be “difficult in the current political and economic environment”.
Instead, what the CWU is pushing for is “a different model of ownership” – that is, where the employees part-own the business.
To get its support for the takeover, the union wants employees to share ownership of the company, along with other concessions including board representation for workers.
It says profit sharing is “not going to be enough to deliver our support and the support of the workforce”.
If the union doesn’t get what it wants, it won’t rule out industrial action, Mr Ward said. Its members went on strike in 2022 and 2023.
Although Mr Kretinsky said he is “very open” to profit sharing, he is not in favour of shared ownership.
“I don’t think the ownership stake is the right model,” he said. “The logic is: share of profit, yes, [but an] ownership structure creates a lot of complexity.
“For instance, what happens if the employee leaves? He has shares, he is leaving, he is not working for the company, he [still] needs remunerating.”
Mr Kretinsky said he didn’t want to create “some anonymous structure” but instead “remunerate the people who are working for the company, and creating value for the company”.
The union is also concerned about job losses and changes to the terms and conditions of postal workers’ contracts.
Mr Kretinsky has guaranteed no compulsory redundancies or changes in terms and conditions but only until 2025.
“If we are more successful, and we have more parcels to be delivered, we need not less people, but we need more people,” he said. “So really, job cuts are not part of our plan at all.”
He said if the management, union and employees work together, “we will be successful”.
Another concern is the potential break-up of the business.
The profit for Royal Mail’s parent company last year was entirely generated by its German and Canadian logistics and parcels business, GLS. Royal Mail itself made a loss.
Mr Kretinsky has promised not to split off GLS or load the parent company with excessive debt, although borrowings will rise if the deal goes through.
But he has a way to go to convince the CWU.
“I can’t think of any other country in the world that would just just hand over its entire postal service to an overseas equity investor,” Mr Ward of the CWU said.
However, Mr Kretinsky said that the postal unions “do understand that we are on the same ship, and that we need this ship to be successful, and that if we are there, we don’t have any real problems to deal with, because the sky is blue, and it’s blue for everybody.”
The union cannot stop this deal but the government can block it under the National Security and Investment Act.
Business Secretary Jonathan Reynolds has said he will scrutinise the assurances and guarantees given and called on Mr Kretinsky to work constructively with the unions.
Mr Kretinsky may say that he and the unions are ultimately on the same ship but, as things stand, they are not on the same page.
Who is Daniel Kretinsky?
Daniel Kretinsky started his career as a lawyer in his hometown of Brno, before moving to Prague.
He then made serious money in Central and Eastern European energy interests.
This includes Eustream, which transports Russian gas via pipelines that run through Ukraine, the Czech Republic and Slovakia.
He then diversified into other investments, including an almost 10% stake in UK supermarket chain Sainsbury’s and a 27% share in Premier League club West Ham United.
The Czech businessman is worth about £6bn, according to reports.
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