After a week of increasing hostility from MPs and economists, the Chancellor Kwasi Kwarteng and Prime Minister Liz Truss have abandoned their policy to abolish the 45% top rate of income tax.
The proposed cuts of £45 billion ($50.5 billion) would have been the biggest in 50 years. Truss and Kwarteng said they were vital to shake the United Kingdom out of years of sluggish economic performance.
What does it mean for mortgages?
Last week’s mini budget and reactions that followed resulted in 40% of all products being pulled from sale by Thursday amid predictions that the Bank of England could be forced to raise the base interest rate to 6% next summer. After the U-turn that forecast fell slightly – to about 5.5%.
In theory, that should translate into slightly cheaper deals. However, some mortgage lenders may take some time to reflect positive news in their pricing, whereas others have gone full steam ahead.
For example, NatWest announced on Sunday that it was raising its rates from Monday. As a result, a new two-year fixed rate aimed at those looking to remortgage has leaped from 4.28% to 5.62%.
With conditions so volatile, lenders also have to assess how much business they want to take on: if they launch a rate much below that of rivals, they might risk being overwhelmed by the demand.
Markets reactions
The pound rallied early on Monday after the policy reversal, initially returning to the level seen before the mini-budget with a gain of almost 2 cents against the dollar to trade close to $1.13.
UK government bond yields, which dictate the interest paid on state debt, also fell a little. Soaring yields partly precipitated the crisis on Wednesday when the Bank of England stepped in to promise to set aside £65bn to buy bonds to ease the pressure on pension funds and insurers. The Bank is continuing with its purchases until 14 October.
What about the public finances?
It is thought that Chancellor Kwasi Kwarteng’s U-turn on his plans to axe the 45p tax rate will do little to ease the pressure on the UK’s public finances. Economists remain concerned about the impact of the rest of the plans.
The government is borrowing heavily to pay for enormous energy subsidies for households and businesses to help them through this winter. And it faces questions over how it intends to pay for the bulk of the tax-cutting package that remains. Cuts to public spending may be next.
Is a recession still on the cards?
Keeping most of the government’s tax and spending plans intact could help reduce the likelihood of recession, but also risks stoking inflation – hence the expectation from economists that the Bank of England will still have to raise rates to pre-financial crisis levels by next summer to try to dampen soaring prices.
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