Market Cheers Partial Withdrawal of UK Tax Cut Plan... "Symbolic Measure" Amid Ongoing Concerns

British Prime Minister Liz Truss (right) and UK Chancellor of the Exchequer Kwasi Kwarteng are talking on the 2nd (local time) in Birmingham, where the ruling Conservative Party's annual conference was held. The UK government announced that it would withdraw the plan to abolish the highest income tax rate just ten days after announcing a large-scale tax cut plan that caused turmoil in the financial market. 2022.10.03 [Image source=Yonhap News]

[Asia Economy New York=Special Correspondent Joselgina, Reporter Park Byunghee] The UK government’s partial withdrawal of the previously market-disrupting tax cut plan led to an immediate positive reaction in the market on the 3rd (local time). Major countries’ government bond yields fell in unison, and stock markets staged a relief rally. However, concerns persist that the market instability originating from the UK has not been fully resolved, as the scale of the withdrawal is only partial. Liquidity concerns surrounding the Swiss investment bank Credit Suisse have also emerged as a new risk in the financial market.

On this day in the New York bond market, the yield on the US 10-year Treasury note fell 19 basis points (1bp=0.01%) from the previous session to 3.64%. The US 10-year yield, which had surpassed 4% last week, declined alongside major countries’ yields after the UK government announced it would not proceed with the most controversial part of its tax cut policy?the abolition of the 45% top income tax rate. The UK 10-year yield dropped 13bp to 3.96%, and the German 10-year yield fell 19bp to 1.92%. Additionally, liquidity concerns related to Credit Suisse further fueled demand for government bonds, reinforcing the downward trend in yields.

As the soaring government bond yields stabilized, major stock markets rebounded. In the US New York stock market, the Dow Jones Industrial Average rose 2.66% from the previous session, marking its largest gain since June 24. The S&P 500 and Nasdaq indices also increased by 2.59% and 2.27%, respectively. European stock markets also closed higher across the board. The value of the British pound, which had plummeted, also rose slightly. In the foreign exchange market, the pound-dollar exchange rate, which had slid to $1.03 on the 26th of last month, recovered to around $1.13 on this day.

However, it remains uncertain whether the effect of this tax cut withdrawal will be sustained. The total tax cut announced by the UK government on the 23rd of last month amounted to ?45 billion (approximately 72 trillion won), but the abolition of the top income tax rate accounts for only ?2 billion (about 3 trillion won) of that. Nomura Holdings pointed out, "The withdrawal of the abolition of the top income tax rate is merely a symbolic measure," adding, "The main framework has not changed."

Ultimately, experts agree that unless the UK government presents a concrete roadmap on how it will secure the necessary funding going forward, downward pressure on the pound and UK government bonds will be difficult to alleviate. This UK-originated financial market instability could increase volatility in global government bond markets and intensify recessionary pressures.

The economic media CNBC reported that UK Chancellor of the Exchequer Kwasi Kwarteng confirmed his intention to proceed with the remaining tax cuts, stating, "The measures taken on this day are insufficient to quell market turmoil." At the Conservative Party annual conference, Kwarteng emphasized, "The tax cut policy caused turbulence," adding, "There are no more obstacles, and now we must move forward."

Market participants are also increasingly wary that recent liquidity concerns surrounding Credit Suisse could lead to a ‘second Lehman crisis.’ Following reports that Credit Suisse is engaging in talks with major investors to address concerns about its financial soundness, anxiety has grown that the company might ultimately go bankrupt. Consequently, on the 30th of last month, Credit Suisse’s one-year maturity credit default swap (CDS) spread surged nearly 4 percentage points in a single day, and on this day, the five-year maturity CDS spread soared to a record high.

The rise in CDS spreads indicates an increased risk of default by the issuer of the bonds. Analysts suggest that the recent sharp drop in the British pound, amid a backdrop of poor investment banking performance due to interest rate hikes, has heightened investor anxiety, leading to the surge in Credit Suisse’s CDS spreads.

However, Mohamed El-Erian, Chief Economic Advisor at Allianz, appeared on CNBC and predicted, "It will not lead to a Lehman crisis." Citibank also assessed that "concerns surrounding Credit Suisse are exaggerated."

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