IMF tells Truss to change tax policy to calm frenzied markets

The International Monetary Fund has added to pressure on Liz Truss’ government to U-turn on unfunded tax cuts announced in last month’s mini-budget, saying changes in policy would help calm jittery financial markets.

Larry Elliott 

On a day when fresh action by the UK central bank failed to halt the upward move in government borrowing costs, the Washington-based IMF said a shift in policy from Truss and her chancellor would “change the trajectory” of interest rates.

The IMF said the Bank and the Treasury were “like two people trying to steer a car in different directions” as it highlighted the turbulence in markets caused by the chancellor’s 23 September package. “That’s not going to work very well,” said the Pierre-Olivier Gourinchas, the IMF’s economic counsellor.

The comments came after fresh action by Threadneedle Street to prevent a “fire sale” of UK government bonds – or gilts – by pension funds caught out by the sharp increase in interest rates in the past two and a half weeks.

Citing a “material risk” to financial stability, the central bank launched the second expansion for its emergency scheme in as many days with a promise to buy index-linked gilts – securities where the interest rate moves up and down with inflation.

In the final week of the scheme, which is due to expire on Friday, it stepped up its efforts to smooth febrile market conditions by buying more than £3.3bn of UK government debt in its single biggest daily market intervention.

Despite efforts in Westminster and the City to smooth over turmoil in the markets unleashed by the mini-budget, leading finance industry figures said the Bank could be forced to extend its emergency scheme beyond this week to prevent a “doom loop” from re-emerging in the bond market.

Speaking at an event in Washington on Tuesday, the Bank’s governor, Andrew Bailey, said Threadneedle Street had no plans to continue with bond buying after the end of this week, adding that his message to the pension industry was: “You’ve got three days left now and you’ve got to sort it out.”

Borrowing costs on long-term government debt rose on Tuesday despite the Bank’s interventions, remaining at levels close to the peak seen in the market turmoil after the mini-budget.

Pensions industry bosses said an extension until the chancellor Kwasi Kwarteng delivered his debt-cutting plans to the Commons on 31 October could be required. Sir John Gieve, a former Bank deputy governor for financial stability, said it was likely to extend the scheme for at least a couple of weeks, while warning that turbulence was directly linked to the chancellor’s unfunded tax cuts.

“He’s actually got to now produce a set of projections which add up,” he said.

The IMF has welcomed Kwarteng’s decision to scrap plans to abolish the 45% income tax rate paid by those earning more than £150,000 and will make a fresh assessment of the UK after Kwarteng’s fiscal statement.

But concerns over the UK and the possible knock-on effects from the turmoil to other countries were voiced at press conferences to launch two flagship IMF publications – the world economic outlook and the global financial stability review.

Gourinchas, responsible for the WEO, said fiscal policy – the tax and spending decisions made by the Treasury – should be aligned with actions taken by the Bank to bring inflation down from a near 40-year high.

The IMF had pencilled in a sharp slowdown in UK growth from 3.6% this year to 0.3% in 2023 before the mini-budget. Growth would be raised “somewhat” but at the expense of making the fight against inflation more complicated.

Tobias Adrian, the IMF’s financial counsellor, said some of the market reaction since 23 September had been “disorderly”, adding that a different fiscal policy would take pressure off the Bank.

“A change in fiscal policy would change the trajectory of interest rates going forward,” Adrian said.

“The change in fiscal policy changed the expectations of monetary policy and meant the Bank of England would have to raise interest rates that much more to bring inflation back to its mandated target.”

Asked whether the only way to solve the UK’s financial markets problems was to reverse the mini-budget, Adrian said: “A shift in fiscal policy would certainly change the trajectory in yields”.

Kwarteng announced £45bn of tax cuts plus energy price curbs for consumers and businesses in his mini-budget, and is working on new proposals designed to reassure markets that the government finances are sound.

Although the chancellor U-turned on plans to abolish the 45p rate of income tax on higher earners, he moved ahead on Tuesday with a cut in taxes on dividends worth £600m for wealthy investors.

Struggling households will however be forced to wait until the end of October to find out whether the government will give the green light to a rise in welfare payments in line with inflation, or whether they will be subject to a real-terms cut amid the cost of living crisis.

Kwarteng stressed to the Commons that “no decisions have been made”. However, the wait for clarity was criticised by Save the Children, which said it was unfair pensioners had been assured their income would rise at least with inflation while parents and carers of children in poverty faced an agonising delay.

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