It’s been a nightmare week for UK assets after the government’s so-called mini-budget put the country’s financial credibility in question and sent panic ripping through markets. Consumers, businesses, and the financial system have all become tangled up in the shockwaves, so much so that the Bank of England had to stage an emergency intervention at one point.
How it all started. That £161 billion ($180 billion) is the estimated cost of Chancellor of the Exchequer Kwasi Kwarteng’s so-called mini-budget and bumper tax giveaway announced on Sept. 23. The worrying aspect for investors was the lack of detail on how this was all going to be funded, particularly at a time of rampant inflation and rapidly rising interest rates.
After Kwarteng promised more tax cuts at the weekend failing to provide some reassurance about fiscal responsibility the pound’s slump continued at the opening on Monday. In the early hours of the UK morning, it dropped to a record low of $1.0350 against the dollar. Sterling then recovered to $1.12 and was trading around $1.11 late on Friday. That’s still about 17% down on where it was at the start of the year.
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The Bank of England’s dramatic intervention to control bond yields earlier this week threatens the central bank’s fight to contain inflation and prevent a decline in pound, according to hedge fund giant Balyasny Asset Management. Traders have also trimmed wagers on aggressive BOE interest-rate hikes, pricing in about 135 basis points of hikes by the next meeting in November, down from as much as 200 basis points on last Monday.
The pound may have recouped most of its drop since Kwasi Kwarteng’s mini budget last week spurred a market meltdown, but stocks dependent on Britain’s economic health are still nursing big losses. The FTSE Local Index of firms that generate at least 70% of sales domestically, is down 12% since the budget through yesterday’s close. Such companies face a plethora of challenges, from the weak pound to higher energy costs and squeezed consumer demand. Meanwhile, the FTSE 100 Index, whose constituents get more than three-quarters of their sales abroad, is down just 3% since the tax cuts were announced.
The government estimates that its aid package to help people with energy bills will cost £60 billion over the next six months, But the program is set to run for two years, so that’s a lot more aid that could be needed. The Institute of Fiscal Studies has estimated a cost of “well over” £100 billion over the time frame.
Prime Minister Liz Truss’s government signaled it’s sticking with its plan for tax cuts after a meeting with the UK’s fiscal watchdog, dashing market expectations that a policy U-turn might be imminent.
A measure of the UK’s credit risk has rocketed, soaring to levels last seen around the Brexit referendum in 2016 and the pandemic fueled-rout in 2020. While the implied probability of default remains minuscule, it has become costlier for investors wanting to insure exposure to UK sovereign debtز
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“Unfortunately, we believe the root cause of the problem which is the loss of confidence in UK fiscal policy will not be addressed” by the BOE’s intervention, said Rufaro Chiriseri, head of fixed income for the British Isles at RBC Wealth Management, who expects a further decline in gilts. Indeed, take the FTSE All-Shares Index, it trades at 8.4 times forward earnings. That’s far cheaper than 13.3 times for a global stocks gauge, the MSCI All-Country World Index. Others simply flag the discounts on offer in London. “If you look at the average UK stock it’s becoming embarrassing how cheap they are getting,” said Peter Toogood, chief investment officer at Embark Group Ltd.
This morning the government has U-turned on plans to scrap the 45p rate of income tax, the chancellor has confirmed. The pound jumped on the news, rising by more than a cent against the dollar to $1.1263.
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