WeeklyWatch – UK’s new chancellor performs huge policy U-turn

18 October 2022

Stock Take

A tumultuous week for UK politics

Bill Clinton’s presidential campaign headquarters had a fairly clear sign reminding his team what mattered most to voters: ‘The economy, stupid!’

The message served him well in 1992. And now, in 2022, UK Prime Minister Liz Truss is learning the harsh lesson of what happens when your messaging isn’t quite right.

UK politics faced another turbulent week, with the departure of now ex-Chancellor Kwasi Kwarteng, the appointment of new Chancellor Jeremy Hunt, and the confirmation of yet another drastic policy U-turn from the Prime Minister.

On Friday, Truss announced that – as anticipated by markets – the mini-budget decision to freeze UK corporation tax had been reversed, and the tax is set to rise to 25% from April next year. But this wasn’t enough to restore markets’ confidence in the UK government, especially considering the rise in government borrowing costs following the news.

On Monday, the U-turn hit its peak, with Hunt announcing the reversal of almost all of Kwarteng’s previously announced measures. This included no longer cutting the basic rate on income tax, and the energy bill freeze now only lasting until April.

Despite a week of uncertainty, markets responded positively to the news, with the pound strengthening, and yields on government bonds dropping in the immediate aftermath.

BoE hits brakes on intervention

In particular, pension funds will welcome these improvements. Last Friday, the Bank of England (BoE) announced that it would conclude its intervention following their purchase of £19.3 billion of UK Government bonds to bolster the pensions industry in the infamous mini-budget aftermath.

Governor Andrew Bailey had candidly told pensions funds they had “three days left now and you’ve got to sort it out”.

Bailey met with Jeremy Hunt over the weekend and recounted that their initial discussions had been “a very clear and immediate meeting of minds.” Their agreement on “the importance of fiscal stability” was already having the desired effect on markets, based on early reactions to Hunt’s statement.

IMF criticises UK tax cuts

The International Monetary Fund (IMF) reduced its global growth forecasts for 2023 last week. IMF said it expected over a third of the world’s economy to shrink, due to high energy and food prices, pressures of the war in Ukraine, and increasingly steep interest rates.

The UK Government’s tax cuts faced heavy criticism after being singled out by the IMF, which said the cuts would “complicate the fight” against soaring prices. This, in addition to the unforeseen news that the UK economy shrank by 0.3% in August, strengthened predictions that the UK is likely to fall into recession.

The UK faces severe inflationary pressures despite the reversal of tax cuts. Mark Dowding, Chief Investment Officer at BlueBay Asset Management, estimates that mortgage costs of two million households are set to double in the upcoming year. In the South-East, for example, mortgage costs account for 40% of wages.

Dowding believes that the threats to the financial system of defaults, plus falling house prices, will result in the Bank of England have to significantly raise interest rates soon. If this were to happen, inflation could remain higher for longer in the UK.

A series of unexpected events

Over in the States, highly anticipated US inflation figures did little to reassure investors last week. Prices rose 8.2% in the year to September, down only marginally on the 8.3% rise in August – confirming that the inflation fight in the world’s largest economy will not be coming to a close any time soon.

The inflation figures triggered a series of unexpected events on Wall Street on Thursday. The S&P 500 index dropped 2.4% not long after opening, but bounced back and ended the day 2.6% higher – although this was mostly put down to short-term hedging activity. This activity led to it being the fifth largest intraday reversal in the history of the S&P 500.

Markets are now estimating a 98% likelihood of a fourth straight jumbo 0.75% rate rise from the Federal Reserve at its 1-2 November meeting.

Some suggested that investors still suspect a mild recession may be on the horizon due to markets’ failure to sell off more sharply. It certainly seems that may be what President Joe Biden is expecting. He said in an interview last week:

“I don’t think there will be a recession. If there is, it’ll be a very slight recession.”

Following the growth surge after the pandemic, Biden has contended that the downturn in economic activity is a healthy shift. He said this ahead of the midterm elections approaching on 8th November.

An analysis by Deutsche Bank showed that the S&P 500 has been higher for a year after every one of the 19 midterm elections since World War Two – perhaps investors can take encouragement from this. However, this year has also seen the S&P 500 register its most falls of at least 1% since 2009. This is certainly one clear example of the rocky landscape of 2022.

Attention will now turn to whether the third-quarter corporate earnings season will clarify the potential performance of the US economy in months to come.

Wealth Check

One thing we can all be certain of, especially when we look back at the unpredictability of the last few years, is that life doesn’t stand still for long.

Having a long-term financial plan is great, and will hopefully help you to feel confident in your financial future. However, no matter how hard we try, there’ll always be some surprises along the way to try and derail our plans.

Just as your investments have their ups and downs over time, so too will your disposable income. There’ll be times when you’re the recipient of unexpected cash, and others when you’ll need to be more careful when spending.

It’s only natural to see lots of exciting opportunities when you receive an unexpected lump sum – it really could go a long way when thinking about financial planning and how to achieve your financial goals.

The best next steps for you will depend on a range of factors, and with the help of a financial adviser, you can work out what will make the most sense for your short- and long-term future. For example, your lump sum could help with a deposit for your first home if you’re yet to buy, or give the younger generation a leg up.

Another option is to put some money towards your retirement, and pay it into a private pension. Alternatively, if it’s a work bonus, ask your employer to contribute into your workplace pension.

Making a pension contribution can be a smart move as, subject to certain limitations, your contribution will also be topped up by tax relief equivalent to the rate of Income Tax that you pay on the basis that any tax relief over the basic rate is claimed via your annual tax return. This means that if you choose to pay this additional tax relief into your pension, it is also benefiting from the tax you would have paid on that income.

If you’re wondering if you’re getting the rate of tax relief you’re entitled to, or how tax relief works in general, speak to a financial adviser today for clarity and advice.

Coming into money can leave you with many feelings, including excitement about the future and apprehension about how to make the most of it. We can offer support and advice about how to make the right decisions for you and your loved ones, and help improve your financial well-being now and in the future.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The levels and bases of taxation and reliefs from taxation can change at any time. Tax relief is dependent on individual circumstances.

In the Picture

Investing in equities offers both the opportunity for capital growth over the medium to long term, and the possibility for a rising dividend income. The graph below shows the upward trend for the level of income from equities, reflecting the ability of strong, well-managed companies to increase their dividends paid to shareholders over time. In comparison, the level of income from deposits is far more volatile.

The Last Word

“It’s a big honour to do the job that I’ve been asked to do by the prime minister, but I want to be honest with people: we have some very difficult decisions ahead.”

– UK Chancellor Jeremy Hunt on his new role.

Bluebay is a fund manager for St. James’s Place.

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