Truss and Kwarteng go all in

Whatever you feel about the appropriateness of the detail in last Friday’s UK “mini-budget”, it is radical and almost certainly a gamble in several ways. Undoubtedly it would be described as “a courageous move” by Sir Humphrey of Yes Minister fame!

The negative perspective is easy. The changes overturn 12 years of Tory policy and happened without any mandate from an election. Fiscal expansion at a time of high inflation, rising rates, and almost full employment doesn’t fit in the conventional economic rule book. The UK currency (GBP) will weaken and the rates demanded on government borrowing will increase at a time of record UK debt, albeit at a lower level than other G20 countries. The last two times a fiscal expansion of this magnitude was tried in the UK – in 1972 and 1988 – the changes preceded an almighty recession and housing market crash.

The positive arguments perhaps need a different mindset. The Tories had, arguably, all but lost the next election already. Business as usual was never going to cut it. On top of that, and seemingly less recognised, what is coming down the track, not just for the UK but the wider western world, is going to be very painful. Payback for kicking the can down the road after the GFC was catalysed by both the post covid lockdown adjustments and the geopolitical changes from the Russian and Ukraine conflict. Recession, higher interest rates, inflation, and lower asset prices all beckon for the UK and also for many other western nations. So maybe the UK government has just got ahead of the curve? Supporting demand might seem inflationary right now but given the coming pressures, things may just end up a touch more stable.

Any expansion of debt will, to an extent, be inflated away anyway. But the final debt burden is also unclear today. The energy subsidy may not be as great as feared, energy prices will stabilise. Oil prices are already lower and electricity pricing is usually, in the UK, set 4 years before it is needed. The high and volatile spot pricing, on which future price expectations and the energy cap are based, is a function of a small trading window for a commodity that cannot be stored. Prices can fall just as quickly as they rose.

Two of the big tax “cuts” were really reversals of yet-to-be-implemented hikes announced by previous chancellors – i.e. their impact had not been felt but would have been extra painful in light of rate rises and other cost of living increases.

Clearly, GBP is going to bear the brunt of the short-term pain but having a flexible currency rate is a positive in the medium term, as it allows for such economic adjustment. Other countries with foreign debt and less flexible exchange rates will suffer more pain. Given the fiscal changes, UK rates will certainly need to be higher than otherwise but mean-reverting rate levels have undoubtedly moved higher given the reversal of quantitative easing anyway. Longer-term, as recession bites elsewhere, GBP should see some support from higher rates, a weaker relative starting point, and an economy structured to maintain demand. UK assets are now seen as cheap by overseas investors and the government cleverly removed VAT for overseas visitors on their UK purchases. This should boost demand for GBP from tourism, around 10% of GDP, adding to flows into the currency which the government hopes for from their supply-side reforms, lower tax rates, development zones, and a simpler planning process (not to mention the removed bankers’ bonus cap).

The budget changes also threw up a positive for WELREX’s Independent Relationship Managers (IRMs). WELREX IRMs work for themselves within their own corporate business. They will be better off due to tax reductions on dividends paid from these corporate businesses. Before the announcement tax on dividends was 39.25%, virtually matching the income tax rate of an employee. This tax has now been reduced back to 32.5%.

Stephen Ashworth

Investment Director