By Ian McConnell

Business Editor

Veteran Scottish economist Jeremy Peat yesterday warned of a “catastrophic state of affairs for the public finances” following a “huge experiment” by Kwasi Kwarteng in the mini-Budget, after sterling plunged to a record low against the dollar.

Mr Peat, vice-president of the Royal Society of Edinburgh, observed the “already sky-high cost of financing the still-unquantified fiscal deficit resulting from Kwarteng’s huge experiment will escalate as interest rates rise”, declaring higher borrowing costs were “inevitable”.

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There was intense speculation in financial markets that the Bank of England could announce an emergency interest-rate hike yesterday. As the stock market closed at 4.30pm, Governor Andrew Bailey said the Bank was “monitoring developments in financial markets very closely in light of the significant repricing of financial assets”. However, he added that the Monetary Policy Committee would make a full assessment of the effect on demand and inflation of the Government’s announcements last Friday, and the fall in sterling, and “act accordingly” at its next scheduled meeting, which is in early November.

The Resolution Foundation think-tank noted that, amid the turmoil, financial markets were now expecting UK base rates to rise to 6% next year, rather than the 5% level they were projecting only last Thursday. The MPC raised base rates by a half-point last week to 2.25%.

The pound plummeted to $1.0327 in Asian trading yesterday, its lowest since decimalisation in 1971. It then rallied to around $1.09 on expectations of an emergency rate hike. It fell sharply after Mr Bailey’s statement, and was by 5pm trading around $1.0688, down 2.32 cents on its pre-weekend close in London and 6.35 cents lower than at 5pm on Thursday.

Financial markets have been spooked by the Conservative Government’s mini-Budget, in which Mr Kwarteng reversed a planned hike in corporation tax which would have raised about £17 billion a year, reversed national insurance rate rises which had taken effect in April, and scrapped the 45p top rate of income tax.

These measures came on top of a previously announced support package for households and businesses for energy bills.

The Government decided that the independent Office for Budget Responsibility should not publish economic and fiscal forecasts last Friday, incorporating the effect of the measures announced.

Mr Peat said: “The market reaction to the new Chancellor’s ‘non-Budget’ last week has been understandably severe and negative. Sterling at one stage crashed to an all-time low and expectations for the future trend in interest rates have shot upwards. This is hardly a surprise given that the cost of the tax reductions announced will be massive, but remains unquantified. The Chancellor refused to allow the Office for Budget Responsibility to estimate the economic and fiscal impacts – when that is exactly what the [OBR] was created for – just like the Scottish Fiscal Commission north of the Border.”

Mr Peat voiced his belief that “the only explanation is that Chancellor and PM were afraid to allow such an impartial and objective analysis, because they knew how negative it would be”.

He declared: “Higher interest rates are inevitable. Alongside higher inflation these will put a brake on growth – in opposition to any ‘non-Budget’ positive effect.”

Underlining the increased cost of financing the fiscal deficit, Mr Peat added: “Overall the most likely outcome is slower growth over the next year or two – or rather deeper recession as growth will be negative – and a catastrophic state of affairs for the public finances requiring urgent action in 2023 and beyond. The Chancellor is promising more. We must hope that even Conservative MPs see the gross error of his ways and that another change at the top comes sooner rather than later.”

Veteran fund manager Colin McLean, managing director of Edinburgh-based SVM Asset Management, said publication of a “medium-term plan for fiscal responsibility” by the UK Government may be needed to stabilise sterling and gilts.

Mr Kwarteng said later that a medium-term fiscal plan would be published on November 23.

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An analysis by Reuters of data from Refinitiv and the Bank of England concluded yesterday morning that 10-year UK gilts were on track for their biggest loss in any calendar month since at least 1957, with yields having surged.

Mr McLean said: “The pound has hit an all-time low versus the US dollar, with the Chancellor’s weekend promise of further tax cuts creating more alarm in international financial markets. For a trading nation such as the UK, with an open economy, the pain will quickly be transmitted to UK businesses and consumers, likely limiting further freedom of action for the Government.”

He noted the pound’s sharp fall since Friday would “ inflationary in the UK given imports of food, energy and other key materials”, with “much of this priced in dollars”.

Mr McLean added: “The Chancellor is reported as saying that he doesn’t comment on market movements, but the weakness of the pound combined with a big fall in gilts may get his attention. In recent years, the UK has nurtured a reputation for prudence in financing, but the UK and international investors are struggling to make sense of this and in particular to see where the limits lie.”

He noted that “most of the national debt is in pounds, and this should mean that UK default on its borrowings is avoidable”.

However, he said: “The cost will be high debt costs, a weak currency and lots more money printing.”

Mr McLean added: “British consumers will also be forced to make hard choices in terms of their spending; although some imports are living essentials, rising prices in imported manufactures and foreign holidays will force substitution of discretionary items. All UK households will see a big cut to real income. The UK has tended to be driven by consumption and housebuilding, but discretionary spending power will fall.”

He noted that “part of the record currency move for the pound is represented by the strength of the US dollar itself”.

Mr McLean added: “It does look as if the US economy is going through a more normal business cycle, with the US Federal Reserve tightening [monetary policy] in a typical and proven way.”