27 September 2022
The new UK Chancellor, Kwasi Kwarteng, delivered a ‘mini budget’ of tax cuts on Friday – a controversial drive, with a vow that there’s “more to come”.
Kwarteng’s series of reforms and changes – which have already brought about a marked movement in the UK market – are said to be the biggest tax cuts in 50 years, making the ‘mini’ description all the more inaccurate.
The fundamental changes included scrapping the 45% Additional Rate of Income Tax, bringing forward the 1p cut to the basic rate of Income Tax, lifting the threshold for Stamp Duty, and removing the cap on banker’s bonuses – in addition to the already announced £2,500 fuel cap freeze.
Payment for these cuts will see the government borrow more heavily than previously anticipated. Kwarteng’s strategy of reducing the debt burden as a percentage of GDP is risky – yet he hopes his policies will encourage investment, grow productivity and spur faster GDP growth.
Sterling and government bonds sold off heavily in response to the announcements, signalling investor jitters over the future state of the UK economy.
Earlier in September, Sterling was trading at a four-decade low of just over $1.13. However, by the start of yesterday, it had dropped to its lowest-ever level of just $1.04.
Paul Dales, Chief UK Economist at Capital Economics, explained:
“Markets have concluded that the result [of Kwarteng’s plan] is likely to be higher inflation and higher interest rates rather than a sustained period of much faster GDP growth. We agree.”
The currency effect
A weak currency can have a multifaceted impact, affecting your portfolio in a variety of ways. Not only does it make imports more expensive and exports cheaper, but – depending on where their supply chains and revenue streams are located – it can also impact businesses differently.
Currency markets are just one factor of many that drive returns, and are renowned as being unpredictable. Having a diversified investment portfolio over the long term can mitigate against currency risk.
Azad Zangana, Senior European Economist and Strategist at Schroders, commented that the ‘mini budget’ put the Bank of England in a tricky position, and that, as a result, future interest rate hikes were now likely to be higher.
“Although the Energy Price Guarantee measure helps lower headline inflation next year by some three percentage points by our estimates, the giveaways, particularly for households, are likely to raise inflation at the end of 2023 and beyond.”
As part of tackling inflation, the BoE itself had already raised the Central Interest Rate by another 0.5% earlier in the week. Delayed due to the Queen’s passing, this move means the rate of 2.25% is now at its highest level since 2008.
The Bank further warned that the UK economy may be under stress, having shrunk between April and June. If the UK economy shrinks between July and September as the Bank predicts, this would put the UK in a recession.
A tough week for markets
UK equity markets had an unsurprisingly challenging week, with the FTSE 100 falling by 3%, and the more domestically focused FTSE 250 slumping by 4.4%.
In the US, the NASDAQ and S&P 500 dropped by 5.1% and 4.7% respectively. This followed on from the Federal Reserve raising its Central Rate by 0.75% for the third consecutive policy meeting. The Fed has taken a notably militant stance lately, with its Chair discussing how rates still have ‘a way to go’ and committing to taking action ‘until the job is done.’
Meanwhile, in Europe, the MSCI Europe ex. UK Index fell 4.3%, as Russian President Putin declared a ‘partial’ mobilisation of Russian men – a move likely to perpetuate the war in Ukraine.
Mark Dowding, Chief Investment Officer at BlueBay, noted:
“Meetings with EU policy makers this week suggest a sense of economic realism in Brussels. There is a sense that recession is a price to pay when there is war on the continent. The question now is how painful this recession will be, and this may be a function of how persistent inflation is, as rising prices imply a material contraction on real disposal incomes.”