The A-Z of Britain Rolling Back Some of Its Contentious Tax Schemes

On Monday, Jim O'Neill explained the situation on CNBC, saying, "It is the result of a highly dangerous budget by the incoming chancellor and a fairly timid Bank of England that, so far, has only increased rates grudgingly despite all the evident pressures." It's because the incoming chancellor's budget is very risky and the Bank of England doesn't want to do anything about it.
Under new United Kingdom Prime Minister Liz Truss, the British government unveiled a mini-budget on Friday with many initiatives targeted at cutting taxes. One of the most important changes for the retail and luxury goods industries was the decision to let foreign tourists buy things tax-free in the United Kingdom again.

In early Tuesday trade, the British pound had recovered somewhat, trading at around $1.078. The Bank of England said it was keeping a close eye on market developments and was prepared to raise interest rates if required to bring inflation back near the 2% level it had set over the medium term in a statement issued on Monday afternoon.

Tax cuts of this magnitude were announced on Friday, the first time this has happened in Britain since 1972. More than that, it was an open embrace of the "trickle-down economics" ideology that Reagan and Thatcher advocated. To combat skyrocketing inflation and a crisis in the cost of living, the United Kingdom made some daring policy moves that put it at odds with the bulk of the major countries elsewhere. 

About £45 billion in tax cuts and £60 billion in energy subsidies to consumers and companies over the next six months will be a part of the fiscal package, which will be funded by borrowing. This occurs as the Bank of England prepares to sell £80 billion in gilts next year in an effort to reduce its balance sheet. Borrowing is how the government's stimulus plan will be paid for.

A recent increase in yields on 10-year government bonds above 4% may signal that investors feel the market believes the Bank of England will need to boost interest rates more aggressively to prevent inflation. There has been a 131-basis-point increase in the yield on 10-year gilts this month. Because of this, the yield on 10-year gilts is about to go up by the most in a month since Refinitiv and the Bank of England started keeping records in 1957. 

Speaking on CNBC on Monday, Citi's head of European foreign exchange strategy, VasileiosGkionakis, said that the massive fiscal stimulus and tax cuts, which were financed by borrowing at a time when the Bank of England is embarking on quantitative tightening, amounted to the market demonstrating an "erosion of confidence" in the United Kingdom as a sovereign issuer, resulting in a "textbook currency crisis." 

He said that the government's assertion that extending fiscal policy in this way will spur economic development is unsupported by "empirical data," and he hinted that an emergency inter-meeting rate rise by the Bank of England was becoming more likely. Both of these arguments were about how the government thinks that increasing fiscal policy in this way will help the economy grow.