Mini budget sets off a mini-quake in gilt markets

‘People are getting out their long-term history books to find an example of worse one-day price moves’

Jim Leaviss

Market reaction to chancellor Kwasi Kwarteng’s mini-budget signalled his spending plans and tax cuts to be unfunded and unprecedented after the pound sunk even further from its 37-year low on Friday, leaving gilts, sterling and equities under tightening pressure.

It is estimated that the measures, which amount to the biggest cut in taxes in a single statement since the 1970s, are set to cost the UK economy £87bn over the coming two years, exacerbating the £150bn Energy Price Guarantee already introduced by the government.

For context, reaction to the mini-budget within gilt markets exceeded price moves caused by the Bank of England, the 2008 financial crisis, Brexit, or the Covid pandemic.

On Monday, early trading in Asia saw the pound fall to just above $1.03.

The FTSE 100, aided by the pressure on sterling, opened higher on Monday on the back of international inclusions buoying the index with translational benefits garnered from the weak pound.

Monday market blues

On the back of the announcement, the Debt Management Office was tasked with raising £72bn in gilt sales, raising the proposed 2022-23 total to £193.3bn, as well as additional Treasury bill sales of £10bn, to fund the tax cuts.

“It’s fair to say that the gilt market hated today’s mini-budget,” says Jim Leaviss (pictured), CIO of public fixed income at M&G Investments. “People are getting out their long-term history books and gilt charts to find an example of worse one-day price moves.”

He points to the combination of the unfunded tax cuts and the energy support measures compounding what has already been a “weak period for government bonds” thanks to global inflation and central bank rate hikes.

Leaviss likens Kwarteng’s ambitions to that of Anthony Barber in 1972 – a budget that generated a short-lived boom. “In practice, the Barber Boom generated inflation and led to the government having to introduce emergency price controls and pay boards. And his party lost the 1974 election,” says Leaviss, who lacks confidence in the Bank of England’s ability to unwind its QE gilt holdings, worth nearly £900bn.

He says the immediate rise in yields will impact new fixed-rate UK mortgages in the near term.

Likewise, Quentin Fitzsimmons, portfolio manager of the T Rowe Price Global Aggregate Bond strategy, says the gilt market and sterling were the “easiest casualties” for the government to target to achieve its growth ambitions.

“Successive UK governments dragged the gilt market into a modern world of institutional transparency, reinforced by the fashionable orthodoxy of inflation-targeting and an independent central bank. These gains, valued by investors, have been rapidly eroded. As the old saying goes, ‘it takes forever to gain credibility, which can also be lost in an instant’.

“For all the excitement of a dash for growth, the UK economy has a lamentable capacity to hang onto such engineered gains. Sterling and the gilt market have very long memories, including a latent form of post-traumatic stress, which may have been triggered,” he says.

Picking up the pieces

The immediate reaction from investors was broadly negative, says Garry White, chief investment commentator at Charles Stanley, pointing to a fall in British shares.

“A rise in the pound would have meant that the UK’s growth outlook would have materially improved. Investors believe that tax cuts and increased public spending could make the UK’s economic situation even worse – and see this gamble as risky. Just putting money into the economy does not result in sustainable long-term growth.”

White says the announcement provided little in the way of support for entrepreneurship and upskilling workers – moves that should “help resolve Britain’s lacklustre productivity”.

But the government’s growth plan, which targets a 2.5% trend rate of growth, places significant emphasis on speeding up legislation surrounding planning.

Richard Stone, chief executive of the Association of Investment Companies, says the move may provide opportunities for investment companies to capitalise on, particularly in the development of new infrastructure projects.

He says the government’s planned drive for growth “needs to be backed by long-term capital” – something that investment companies are “perfectly positioned to provide”.

“Investment companies manage £33bn of infrastructure assets, including £18bn in renewable energy infrastructure, and fundraising for these sectors has remained strong this year despite a more uncertain economic environment. Investment companies are well placed to accelerate development of UK infrastructure by providing permanent capital to projects critical for economic growth,” he says.

However, Tom Hopkins, portfolio manager at BRI Wealth Management, opts to look to the long term.

“This mini-budget has already received a lot of criticism, with many accusing Kwarteng of ramping up borrowing just when doing so becomes expensive. When coupled with permanent tax cuts, many have criticised that this budget will push borrowing to unsustainable levels.

“It’s important to remember these sorts of measures do take time to bear fruit. They’re no quick fix,” he says.

Above all else, confidence in the UK economy appears to be rattled, suggests Leaviss, who concludes that “it is noteworthy that one of the big investment banks has not increased its growth forecast for the UK as a result of this fiscal splurge”, he says.

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