Sterling is tumbling more sharply, as the financial markets give their verdict to the swathe of unfunded tax cuts announced by Kwasi Kwarteng this morning.
The pound has dropped below $1.11 against the US dollar, for the first time since 1985, as investors baulk at the huge extra borrowing needed to fund today’s plans.
Rachel Winter, Partner and Investment Manager at Killik & Co, says the recent weakness of sterling illustrates a lack of confidence in the government’s plans.
The pound is down 15% against the dollar over the last six months, and this morning’s budget has sent it down further.
This chart shows how UK bonds are slumping (pushing up yields) while other sovereign debt prices are much more stable:
UK government bonds have been hammeded by concerns about the extra borrowing needed to fund chancellor Kwarteng’s huge tax cuts.
The yield, or interest rate, on two-year UK gilts is surging, hitting to its highest level since the financial crisis of 2008.
Two-year gilt yields have jumped by 37 basis points, a massive one-day move, to over 3.8%.
Benchmark 10-year gilt prices have also weakened, pushing up their yield to the highest since 2011.
RLAM Head of Multi Asset Trevor Greetham says Kwarteng’s package would have made more sense after the financial crisis of 2008 – rather than today.
“Action to help struggling households and businesses pay their heating bills this winter was essential, but the scale of the tax cuts and spending increases in this announcement is breath-taking.
Arguably, a significant, unfunded fiscal stimulus package like this would have made economic sense after the deflationary Global Financial Crisis, when borrowing costs were low and private sector balance sheets were deleveraging. Now with spare capacity non-existent, inflation at a forty year high and the Bank of England trying to cool things down, we are likely to see a policy tug of war reminiscent of the stop-go 1970s. Investors should be prepared for a bumpy ride.”
Over in Parliament, Kwasi Kwarteng has announced a staggering swathe of tax changes – in what appears to be biggest tax event since the early 1970s,
The chancellor has produced a huge rabbit from his hat – scrapping the 45% higher rate of income tax entirely, and cutting the basic rate from April 2023 from 20% to 19%.
Kwarteng also cancelled next year’s increase in corporation tax from 19% to 25%, scrapped planned increases in duty rates for beer, wine and cider, abolished stamp duty below £250,000 – and £435,000 for first-time buyers – and is winding down the Office of Tax Simplification (OTS).
The chancellor confirms almost 40 investment zones will be created with tax breaks for businesses, ditched the bankers bonus cap, and will bring forward measures to streamline regulations and remove EU-derived laws.
He also announced the government will legislate to tackle “militant trade unions” from closing down key infrastructure through strikes.
The laws will require unions to put pay offers to a member vote, to ensure strikes can only be called once pay talks have genuinely broken down.
Here are all the key points:
Another worrying sign – UK business optimism about the year ahead has hit its lowest level since the start of the pandemic in May 2020.
Bosses are increasingly anxious about the fall in business, and the surge in costs.
Dr John Glen, CIPS Chief Economist, explains why they are so worried:
“Business activity across the UK private sector fell at the fastest pace since January 2021 in September, with the headline index posting in contraction territory for the second month in a row.
Nerves about the strength of the UK economy impacted on new client wins as customers affected by cost of living pressures scaled back spend. Costs and prices charged remained elevated, and even with rates of inflation moderating since August, they were among the highest since the survey began in 1998.
And with interest rates at a 14-year high fo 2.25%, there’s little to cheer businesses.
The highest rise in interest rates for 14 years also means borrowing costs are now the highest since 2008, so there’s too little in the reserves to make private sector businesses look on the bright side as UK recession fears grow.”
The UK downturn is likely to intensify as we head into winter, Chris Williamson of S&P Global Market Intelligence adds, as the Bank of England continues to lift interest rates as Britain enter recession.
Britain’s private sector is shrinking at the fastest pace since the Covid-19 lockdowns of January 2021, data just released shows.
The Flash UK PMI Composite Output Index, which tracks activity across the economy, has dropped to 48.4 this month, which is a 20- month low.
That’s down on August’s 49.6 – any reading below 50 points shows the economy contracted. It’s another sign that the UK economy is in recession.
The report shows that cost pressures remain high and demand waned. Services sector firms contracted this month, for the first time since February 2021, while manufacturing continued to shrink.
Chris Williamson, chief business economist at S&P Global Market Intelligence, explains:
UK economic woes deepened in September as falling business activity indicates that the economy is likely in recession.
Companies report that the rising cost of living, linked to the energy crisis, and growing concerns about the outlook are subduing demand and hitting output levels to an extent not seen since 2009, barring the pandemic lockdowns and initial 2016 Brexit referendum shock.
Firms were hit by the fastest fall in new business in 20 months (again, since the winter lockdowns of 2021).
Export orders fell at a “sharp and accelerated rate”. Goods producers suffered the sharpest drop in foreign demand for 28 months and services companies were hit by the first reduction since December 2021.
The PMI survey also shows that inflationary pressures are running hotter than at any time in the survey’s history, before the pandemic.
Those cost pressures are being driven by the weaker pound – which pushes up import costs, as well as ongoing supply chain problems and soaring energy prices.
With UK consumer confidence at record lows, and the pound at its weakest since 1985, the economic outlook is darkening almost by the hour….
Kwasi Kwarteng is about to deliver the mini-budget – my colleague Andew Sparrow is live-blogging all the details here:
Sterling is continuing to hit new lows against the dollar (which is strengthening against other currencies too this morning).
The pound has now dropped by a cent this morning, to as low as $1.1165.
Steve Clayton, fund manager at HL Select, explains:
The US dollar continues to climb as investors look to the safe haven of the world’s most liquid asset at a time of economic and political turmoil. The flip side of that is weakness in other currencies.
This morning a euro buys you just 98USc, a decisive break below parity with the dollar. Brits contemplating transatlantic trips might want to run the numbers one more time, because a pound sterling now buys just $1.12, almost 20% less than it did a year ago.”
The downturn in the wider eurozone has also deepensed this month, as price pressures intensify.
Business activity in the euro area is contracting for a third consecutive month, the flash PMI survey from S&P Global shows.
Although only modest, the rate of decline accelerated to a pace which, barring pandemic lockdowns, was the steepest since 2013.
Forward-looking indicators, such as new order inflows, backlogs of work and future output expectations, point to the decline gathering further momentum in coming months.
Germany’s economic downturn has deepened this month, as businesses were hit by soaring energy costs and a drop in new business.
Germany’s services firm, and its manufacturing sector, both contracted this month according to a ‘flash’ reading from data provider S&P Global.
Demand for goods and services deteriorated rapidly this month, due to surging energy costs and an increasingly uncertain outlook.
The data suggests Germany is heading towards recession – and has knocked the euro to a new 20-year low against the dollar, further below parity.
Phil Smith, economics associate director at S&P Global Market Intelligence, said:
“The German economy looks set to contract in the third quarter, and with PMI showing the downturn gathering in September and the survey’s forward-looking indicators also deteriorating, the prospects for the fourth quarter are not looking good either.
The deepening decline in business activity in September was led by the service sector, which has seen demand weaken rapidly as customers pull back on spending due tightening budgets and heightened uncertainty about the outlook.
ING predict the pound will continue to lose ground against the US dollar, and could hit $1.10 in the next month (it’s currently $1.119 after this morning’s drop).
ING’s global head of markets, Chris Turner, says investors have doubts about the government’s plans:
“Sterling net-net was a little lower after yesterday’s divided Bank of England hike.
Today sees the big reveal of Chancellor Kwasi Kwarteng’s ‘fiscal event’. As noted recently, typically looser fiscal and tighter monetary policy is a positive mix for a currency – if it can be confidently funded. Here is the rub – investors have doubts about the UK’s ability to fund this package, hence the Gilt underperformance.
“With the BoE committed to reducing its Gilt portfolio, the prospect of indigestion in the Gilt market is a real one and one which should keep sterling vulnerable.
Sterling isn’t very impressed by Kwasi Kwarteng’s plans, says Neil Wilson of Markets.com.
The widening trade deficit, which rose to almost an all-time high £27bn in the three months to July, is one half of a twin deficit that leaves traders bearish on the pound.
And all these tax cuts won’t help the other half of the UK’s twin deficit – the budget deficit – and it could lead to further re-pricing for sterling.
Wilson adds that “abandoning any semblance of fiscal discipline” is not usually a recipe for long-term confidence in the country’s assets.
Derek Halpenny, head of research at MUFG, said in a note he sees risks the pound could fall further over UK government policies that could possibly “lack credibility”.
Halpenny adds that the mini-budget could raise concerns over external financing pressures as “the budget and current account deficit combined looks to be heading to around 15% of GDP.”
Of the international banks and research consultancies polled by Reuters last week, 55% said there was a high risk confidence in British assets would deteriorate sharply in the coming three months.