We had taken the view to delay making reactive comment on the new Chancellor’s mini-budget last Friday, but market movements provide an impetus to do so.
The published commentary is broadly negative, as is the reaction of financial markets, viewing the unfunded nature of the tax cuts economically and politically dangerous, especially as plans were not independently backed by the Office for Budget Responsibility (OBR), as would normally be the case. The Institute of Fiscal Studies (IFS) suggests government borrowing is set for the third highest level since WWII at £190bn, with financial markets not taking kindly to such indebtedness (1).
The Chancellor is taking a risky and costly stance in the near-term, albeit partly necessary in capping energy costs, but there are arguably better targeted tax cuts that could have been made to help with the cost of living crisis, rather than abolishing the 45% income threshold and reversing dividend tax rises. The energy cap will have a significant impact in lowering inflation, thus protecting households and businesses somewhat this winter, but taking such a bold path has had the impact of significantly reducing the value of the pound and therefore making import inflation potentially worse.
The Bank of England (BoE) is likely to raise interest rates even higher in response to stave off inflation, which will have a direct affect on mortgage rates and the housing market that is such a crucial part of the UK economy. Mortgage providers have already been withdrawing products given the uncertainty of the future interest rate path.
The International Monetary Fund (IMF) unusually released a statement to the same point (2):
“Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture. It is important that fiscal policy does not work at cross purposes to monetary policy.”
It will be interesting to see if the OBR is damning or supportive of the announced policies but markets have cast their vote already. The benchmark 10-year government gilt yield rose from 3.5% to a high of 4.5% and the pound hit an all-time low relative to the US dollar of $1.03, down from a high of $1.42 in June 2021.
The movement in the currency represents both concern that the UK is not acting prudently and also a natural adjustment mechanism to make investment into the UK better value to outside investors, as at some point UK assets become attractive.
So that’s the negative take, but our independent economist, John Calverley of Tricio Investment Advisors questioned whether there was anything positive to be considered, in particular the longer-term impact of the proposed reduction of tax rates (3):
“Extra demand in the near term is just inflationary. Only supply-side changes, which encourage work and boost productivity can raise growth. Here the news is (generally) good, though the question is whether it is enough to move the macro dial.”
Lower national insurance, income and corporation tax rates should incentivise employment and overseas investment, if the Chancellor’s plans prove credible and he is not forced to row backwards in the coming weeks.
As we write, and as expected, the BoE just announced its intention to intervene in the current ‘dysfunctional’ gilt market to maintain financial stability, by purchasing longer-term gilts in the market to keep borrowing costs down (4). It has also been suggested that this move from the BoE is to support liquidity in a very important market in which pension funds are reliant.
This statement has had the immediate effect of lowering the benchmark 10-year government bond yield to near 4% from 4.5% before the intervention, but this could just prove respite for the moment, as markets await any upward move in interest rates. However, the bank also just reiterated:
“The Monetary Policy Committee (MPC) will not hesitate to change interest rates as much as needed to return inflation to the 2% target sustainably in the medium-term.”
So, the reality is that interest rates will be rising to a level previously unexpected, just at a time when government debt is climbing.
This not so mini-budget has had a huge impact and there is no getting away from the fact that the UK is in a difficult position and has to prove its mettle after years of slow growth. The short-term pain is being felt, but it might just be worth it if the country can incentivise business sufficiently to invest for the future and the government can grow its way out of debt.
FPC’s clients will recall that their well-diversified portfolios are invested on a global basis, not just in the UK, so the fall in the currency actually has some benefit by making overseas values higher when converted back. Our clients will also know that temporary periods of market difficulty are not a new phenomenon and will pass in time. Just like during the recent pandemic, it can be surprising how quickly confidence in markets can be restored.
If you have any concerns or queries on any elements of the Chancellor’s mini-budget, please don’t hesitate to contact us on 01704 571777.
1.IFS – Mini-budget-response. 23rd September 2022.
2.Financial Times – IMF urges UK to re-evaluate tax cuts in biting attack on fiscal plan. 28th September 2022.
3.Tricio – UK budget not all bad economics. 25th September 2022.
4.Bank of England – announces gilt market operation. 28th September 2022.