Fears over income tax cuts and debt caused the British pound to drop to a record low 2022

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Written By mukesh

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Fears over income tax cuts and debt caused the British pound to drop to a record low. As traders and investors continue to react negatively to new plans unveiled last week by the United Kingdom’s finance minister, Kwasi Kwarteng, the British pound fell to a record low level in relation to the U.S. dollar shortly after the international currency markets opened for the week in Asia on Monday.

The pound briefly reached its lowest level ever against the dollar, trading at just over $1.03, before marginally rebounding to about $1.07, though it remained close to its worst levels in the previous 40 years. 

The Bank of England, the country’s central bank, has recently issued a warning that the UK may already be in a recession. Kwarteng addressed Parliament last week with the promise of a new economic era for the U.K. He was appointed chancellor of the  Exchequer (head of the Treasury) under the new Prime Minister Liz Truss this month. 

Will Tax reduction will help the Pound?

His plans included the biggest tax reductions in 50 years while also increasing borrowing to fund government spending. Kwarteng  claimed that tax cuts for both businesses and the nation’s highest earners would encourage investment and boost the economy, with taxes from a stronger economy intended to make up any shortfall caused by lower tax revenue. 

But even if it does, economists claim that it won’t happen right away. Investors who were taken aback by the size of the tax cuts are also worried that the government will need to borrow more money from international markets in the near future to make up the shortfall in tax revenues. Lenders will start to charge higher interest rates as loans to Britain become more risky, increasing the cost of servicing Britain’s debt as a result.

The announcement has also raised concerns about how it will affect Britain’s already-high double-digit inflation rate.  A weaker pound will increase the cost of imports, which will add to the upward pressure on prices. These imports will be denominated in foreign currencies like dollars, yuan, and euros. This is especially true for imported oil and gas since they are all priced in US dollars. 

Another potential factor that raises inflation is that people who benefit from tax cuts might have more money to spend. This could force the Bank of England, the nation’s central bank, to raise interest rates in order to uphold its commitment to keeping inflation at or below 2 percent.

These higher rates may support the pound in the short term by encouraging investors to purchase British assets due to the higher returns. However, in the long run, higher interest rates will have a significant impact on British homeowners due to higher mortgage payments. 

Additionally, they might deter individuals or companies from taking out loans, which can impede long-term economic growth. 

The new Conservative government has come under heavy fire from well-known economists around the world as well as the opposition Labour Party for trying to steer the same economy in two different directions at the same time. 

Trickle-down economics isn’t the solution, according to Rachel Reeves, the spokesperson for Labour on finance. She also claimed that Kwarteng had “fanned the flames” of the pound’s decline by hinting in an interview on Sunday that he would implement additional tax cuts in the coming months.

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