Kwarteng’s tax U-turn was inevitable – and he has already done damage

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“A little turbulence”. That was Kwasi Kwarteng’s attempt to put the horror show of the past 10 days to bed. “No more distractions,” the chancellor added. It was time to focus on the job at hand. Move along. Nothing to see here.

It seems unlikely Kwarteng will get away with it that easily. In the financial markets there was respite after last week’s mayhem, but also a sense that the decision by the man responsible for the UK’s Treasury policy to abandon plans to scrap the 45% top rate of income tax paid by those earning more than £150,000 was too little, too late.

The humiliating U-turn forced on the government will have economic as well as political consequences. A week of turmoil in the financial markets showed just how badly his mini-budget had gone down with international investors. The pound fell, the cost of government borrowing rose, mortgage products were pulled.

Liz Truss’s government has made faster growth its central mission, and that aspiration was the central theme of Kwarteng’s speech. But the mini-budget was threatening to deliver a brutal squeeze on activity caused by dearer imports and higher interest rates: the opposite to what the new prime minister had wanted. Hence the U-turn.

Tax U-turn wins Truss some time but damage to credibility remainsRead more

In itself, scrapping the top rate of tax was relatively small beer. Britain is a £2tn-plus economy and the cost of abolishing the 45% rate is estimated to be about £2bn a year. It made up less than 5% of Kwarteng’s £45bn package of tax cuts.

For the markets, though, the problem was that abolishing the top rate symbolised everything they didn’t like about the mini-budget: the fact that the tax cuts were unfunded, that they might lead to higher inflation, and that they were likely to prompt a tough response from the Bank of England. And, as Truss’s heroine Margaret Thatcher once put it: you can’t buck the markets.

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The initial response to the inevitable U-turn was moderately encouraging for the government. Sterling rose by about a cent against the dollar and bond yields – the interest rates paid to the investors who finance new UK borrowing – fell back a little. Signs of an economic slowdown in the US helped boost the pound and gilts further late in the day.

But the gains were modest and yields are much higher than they were when Truss became prime minister just four weeks ago. Even after the policy shift, the short-term consequences of the mini-budget will be negative. In the circumstances, Kwarteng’s mention of the Conservatives facing the “full force of Labour’s incompetence” in 2010 showed a lot of nerve.

00:03:29From mini-budget to market turmoil: Kwasi Kwarteng’s week – video timeline

Fiona Cincotta, a senior financial markets analyst at City Index and Forex.com, said: “The pound has been behaving more like an emerging market currency in recent weeks, and this behaviour from the government will do little to change that perception.

“The first major U-turn within the first month of rule isn’t exactly an encouraging start for Liz Truss’s government. The move could potentially limit gains in sterling as the market frets over the government’s ability to ride this storm out in a coherent manner.”

Paul Johnson, the director of the Institute for Fiscal Studies thinktank, said another consequence of the mini-budget was that the government would now be forced into spending cuts, something Kwarteng failed to rule out in a speech that sought to emphasise his “ironclad” commitment to fiscal discipline.

As far as the markets are concerned, that pledge has come 10 days too late. Policy mistakes – especially policy mistakes as big as that over the 45% rate of tax – have serious and lasting consequences. An already weak economy has suffered unnecessary damage.

Truss led the standing ovation at the end of Kwarteng’s speech. Few were fooled. If a fall guy is needed, Kwarteng will be it. His reputation has been shredded and may never recover.