Sterling fell as much as 3 per cent against the dollar to $1.09, its lowest point since 1985, after UK chancellor Kwasi Kwarteng took a huge political gamble with a debt-financed package of £45bn of tax cuts.

The biggest set of tax cuts for 50 years includes axing the 45p additional rate for the highest earners as well as a sharp reduction in taxes on dividends.

But concern about the amount of debt needed to finance the tax cuts and billions of pounds of energy subsidies sent the cost of borrowing sharply higher as the pound slid to a 37-year low. Krishna Guha, vice-chair of Evercore ISI, said there was now “a serious risk of a full sterling crisis”.

The Institute for Fiscal Studies forecast that public borrowing would top £190bn this year, the third-highest peak since the second world war, and remain more than £110bn by 2026-27, ensuring that the public debt burden continued to rise.

The additional borrowing is far more expensive for the government than previously, with the two-year cost of borrowing rising to 3.9 per cent from 0.4 per cent a year ago, as investors sold off UK government bonds.

The chancellor has staked Conservative political fortunes on the belief that the radical tax cuts and deregulation will raise Britain’s sluggish growth rate to 2.5 per cent.

“This is a new approach for a new era focused on growth,” Kwarteng told MPs, to a chorus of Tory cheers and jeers from the Labour benches.

By contrast with previous big tax cuts in the 1980s, Kwarteng will borrow tens of billions of pounds to fund his plans, adding to demand at a time when the Bank of England is raising interest rates to bring inflation under control.

Paul Johnson, director of the IFS, said: “The plan seems to be to borrow large sums at increasingly expensive rates, put government debt on an unsustainable rising path, and hope that we get better growth.”

The National Institute of Economic and Social Research said that, due to the additional borrowing, a UK recession would now be shorter and shallower than was feared. But to keep inflation under control, it said the BoE would have to raise interest rates to 5 per cent and keep them there until at least 2024.

The basic rate of income tax will be cut from 20p in the pound to 19p next April and national insurance will be cut, as will taxes on dividends. Stamp duty will be reduced to help first-time buyers and a planned corporation tax rise will be scrapped.

The reductions in income tax mean that an individual earning £200,000 stands to make annual tax savings of nearly £4,500 in 2023-24 compared with 2022-23. A worker on a salary of £20,000 will save £218.

The combined cost of the tax cuts by 2026-27 will be almost £45bn. Kwarteng told MPs in a House of Commons statement that his aim was to turn “the vicious cycle of stagnation into a virtuous cycle of growth”.

The chancellor’s package combined tax cuts with a series of supply-side reforms that he admitted could be unpopular in the short term; he insisted he would be “unashamedly” pro-growth.

However, he admitted the transformation of Britain’s growth prospects was “not going to happen overnight”. For Liz Truss’s new government, which took office only this month, time is of the essence because an election is expected in 2024.

Anticipating criticism that he was giving undue help to the rich, Kwarteng reminded MPs that the government was intervening to hold down domestic and business energy bills. He said the cost of the energy package for the first six months would be £60bn.

Kwarteng confirmed he was scrapping the cap on bankers’ bonuses, a move intended to make the City of London more competitive but which leaves the Conservatives open to Labour claims that it is still “the party of the rich”.

Meanwhile, his lifting of a ban on shale gas fracking and a promised overhaul of environmental legislation to speed up infrastructure projects have enraged the green lobby.

His borrowing spree — coming at a time when the cost of servicing government debt is rising sharply — is viewed by Labour leader Sir Keir Starmer as a significant moment: Starmer wants to claim the mantle of fiscal responsibility at the next election.

Rachel Reeves, the shadow chancellor, described the mini-Budget as “one last throw of the dice” by the Tory government after “12 years of economic failure”. She warned that government borrowing was too high just as interest rates were rising.

Among other measures announced by Kwarteng, corporation tax rates will stay at 19 per cent, but he will maintain the 8 per cent charge on bank profits, which was due to be reduced next year.

The government’s fiscal rules, which stipulated that debt should be falling as a share of gross domestic product within three years, would be reviewed. “In due course, we will publish a medium-term fiscal plan,” Kwarteng said.

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