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The UK’s new Chancellor of the Exchequer, Jeremy Hunt, who took over from Kwasi Kwarteng last week after the latter was ousted by prime minister Liz Truss just 38 days in the role, announced a wide-ranging backtrack on many of the promises in the so-called mini-budget.
“It’s all contextual. This situation wouldn’t have
happened two years ago, pre-Covid.”
TS Lombard’s UK economist, Konstantinos Venetis, said that the market’s volatile reaction is a result of the shift from low to high inflation rates over the past year and a half. The Fed’s aggressive monetary stance in the US, for example, affected how people viewed other sovereign nations’, like the UK's. “When the Chancellor sets an aggressive fiscal policy bar, punishing this approach is much more difficult. It’s all contextual. This situation wouldn’t have happened two years ago, pre-Covid.”
Hunt said he was scrapping the suggested cuts to taxes, which have been labelled ‘unfunded’ and were partly responsible for the market volatility.
Several UK pension funds were rumoured over the past few weeks to have been near breaking point due to the sudden market changes the mini-budget caused. Kwarteng’s mini-budget at the end of September caused panic in the market and the cost of gilts. It also saw the pound fall to record lows against the US dollar.
Hunt would keep some part of the mini-budget; the changes to stamp duty and the National Insurance rate would stay, as would the controversial removal of the cap on bankers' bonuses.
The energy relief plan for UK householders to cope with the higher cost of living over the weekend was also being rejigged, Hunt said and was now guaranteed until April 2023 only.
“Markets are still expecting Bank Rate to peak at 5.2% next summer,
though this pricing has been pared back since the fiscal U-turn.”
“For the time being though, the moves by the Chancellor will reduce the need for the Bank of England to act as aggressively. Having pencilled in a 100 basis-point rate hike in November, we now think that’s more likely to be 75bp,” said ING’s Developed Markets Economist, James Smith, on the UK’s energy cap U-turn.
Smith said the U-turn risked higher inflation and deeper recession. “Markets are still expecting Bank Rate to peak at 5.2% next summer, though this pricing has been pared back since the fiscal U-turn,” he added. “This leaves the Bank with a difficult decision: meet those expectations and bake in what are now very uncomfortable mortgage and corporate borrowing rates. Undershoot investor expectations and the pound could fall materially."
He added that in practice a weaker pound – and the extra imported inflation that might bring – is probably more desirable than the current strains that are starting to emerge as a result of ultra-high borrowing costs. “The challenge for policymakers will be to gradually talk down market rate expectations without causing abrupt pressure on the currency,” Smith said. He added there could be a 75bp hike in November will be followed by another 50-75bp hike in December. “We think Bank Rate will peak somewhere between 3.5 to 4%,” he said.
The mini-budget was largely seen as a disaster for the UK’s government and saw it even be given a rare rebuke by the International Monetary Fund. “We do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy,” said the Fund’s statement.
TS Lombard’s Venetis added that recent U-turns by Jeremy Hunt will give the market some reassurance. “The regulators might see these moves as a sign to take profits as they are for now. Which is why we’ve seen yields come down so aggressively in the past few days.”
"We don’t want to see people having to spend more on the basics.
We want demand to cool so there’s a chance of lowering inflation rates."
“We’ll have to see how these developments guide the market in the new year. Mortgage rates are going up. Fiscal prudence and borrowing doesn’t necessarily mean a lot to the average person, but they do want to see their mortgages increase. In the new year, we might see hikes by the Bank of England (BOE). We don’t want to see people having to spend more on the basics. We want demand to cool so that there’s a better chance of lowering inflation rates.”
Venetis added that if there are no U-turns there could be an aggressive rate hike by BOE in November. “But now there will be maybe less aggressive hike, which is good for people who have mortgages.”
He also added this could see long-term effects, especially, for green energy and the transition to renewables. “The transition to green economy won’t happen as quickly as people think – the government’s new initiatives to allow more fracking are a panic reaction to jumping gas prices in the UK," he said.
“Looking ahead, there is a huge amount of investment that we need to do in the private sector for green investment to become less invested in oil and gas,” he said. “We need better infrastructure and on the fiscal side it’s a matter of how governments will control and moderate increasing debt. Which needs to be financed and the states need to play a big role.”
