IMF tells UK to rethink tax cuts as Moody’s says rating at risk

THE International Monetary Fund urged the UK government to reconsider the massive unfunded tax cuts announced last week, while Moody’s Investors Service said the plan could do permanent damage to the public finances.

The IMF said fiscal stimulus is inappropriate given the inflation pressures in the UK economy, and the package risks making life harder for the Bank of England. Moody’s forecast that it will lower economic growth — contradicting the view from Chancellor of the Exchequer Kwasi Kwarteng — by pushing up interest rates.

The warnings come amid dramatic moves in UK asset prices in the wake of the government’s mini-budget.

The pound touched a record low against the dollar on Monday after Kwarteng brushed off criticism of his economic vision and said he has more tax cuts in the works. Borrowing costs have jumped across the UK financial system since his announcement last Friday and banks have started pulling mortgages deals, triggering a collapse in home sales.

Traders have braced for further tightening from the Bank of England in response to the stimulus plan, wagering at one point on the central bank’s key rate hitting 6.25% in 2023, which would be the highest level since 1999. Kwarteng is due to defend his policy in a meeting with US bank executives in London Wednesday.

“Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy,” a spokesperson for the Washington-based IMF said late Tuesday. “Furthermore, the nature of the UK measures will likely increase inequality.”

The IMF also said that Kwarteng should use a plan scheduled for release in November to “re-evaluate the tax measures, especially those that benefit high-income earners.” Moody’s said that large unfunded tax cuts are “credit negative,” raising the prospect of the UK’s rating being downgraded.

The pound declined 0.6% to $1.0672 as of 9:35 a.m. London time, after hitting a record-low of $1.0350 earlier this week. The yield on the 30-year gilt rose to the highest level since 1998, ahead of a sale of UK government debt.

David Frost, who negotiated the UK’s Brexit deal with the European Union, dismissed the IMF’s criticism, saying in comments to the Daily Telegraph that the Fund’s “conventional” thinking was responsible for years of poor economic performance.

In a sign of how divisive the policy is, even among Tory MPs, the former Northern Ireland Secretary Julian Smith responded with cry of despair at such thinking.

The critique came hours after billionaire investor Ray Dalio said on Twitter that the UK government is “operating like the government of an emerging country.”

On Monday, Federal Reserve Bank of Atlanta President Raphael Bostic said “the proposal has really increased uncertainty and really caused people to question what the trajectory of the economy is going to be.”

Martin Muhleisen, a former director of the IMF’s strategy, policy and review department, said “it is rare for the fund to comment on large members’ economic policies outside the context of its annual Article IV consultations,” referring to the fund’s yearly evaluations of its countries.

“The fund was relatively silent in the run-up to higher inflation in advanced economies, but it is appropriate to point out that fiscal discipline will have to play a part in bringing it down again,” he said.

The IMF and UK have a complicated history. The country secured a loan of about $4 billion from the lender in the 1970s amid a plunging pound and surging inflation, while more recently they have been at odds over the budget austerity imposed following the 2009 recession and then over the country’s divorce from the European Union.

Kwarteng is so far sticking by his proposals.

He told a meeting of leading financiers that he was confident his approach “will work,” according to a readout from the Treasury. “We are committed to fiscal discipline,” he said.

By the time that plan is released in November, interest rates are almost guaranteed to have been increased. Bank of England chief economist Huw Pill said on Tuesday that the fiscal announcement and the market reaction to it required a “significant” monetary policy response. – BLOOMBERG