Picking the bones out of the (not so) mini Budget
Social Media, Newspapers, Broadcasters and Think Tanks inevitably see economic events through their own subjective lens. For some of these platforms, Kwasi Kwarteng’s “Mini budget” was a long-overdue pivot towards a lower tax, smarter regulated UK economy. For others it was a regressive gamble that owed more to shoring up Conservative support than sound economic management.
In contrast to these subjective and verbose opinions, investors and traders in financial markets objectively allocate their monies where they see the best returns. Yesterday financial markets looked at what Kwarteng and new Prime Minister, Liz Truss, were proposing and took money out of the UK. Sterling fell in value. UK government debt fell in value. Shares in UK companies fell in value. Owning a slice of UK plc was deemed to be rather less attractive because of the proposals unveiled.
And yet this verdict is not because the “Plan for Growth” won’t work. Reducing the overall tax burden, eliminating regulatory hurdles for infrastructure, greenlighting onshore wind, and repealing EU laws not appropriate for the UK economy might yet support a higher level of economic growth. No, yesterday was a day when financial markets grew tired of the UK government’s approach to managing the economy.
In recent years investor patience has been tested with a triumvirate of challenges. Firstly, since the Global Financial Crisis in 2008 a recasting of the financial services industry has diminished the centrality of the UK’s global role. UK banks have become smaller and more domestically focused. The incentive to allocate capital to the UK has therefore gradually diminished. Secondly, since the Brexit vote in 2016 UK assets in public and private markets have been at significant and persistent discount of around 25%. This is because investors judged the fallout from Brexit on political stability and trend economic growth to be significant, and negative. So far since 2016 these judgements have been correct. Finally, through the COVID-19 pandemic, financial support was doled out on the implied understanding that as the economy normalised so would the budget deficit. These three events have chipped away at the UK’s reputation as a secure place for investment.
Too many UK politicians of recent vintage see economic strategy as abstract. Something to be debated about in an Oxbridge tutorial, or at a summer drinks reception. Low interest rates for more than a decade have enabled this false reality to take hold. Benign global inflation has allowed a steady devaluation of the Pound to be absorbed into consumer prices. The impact of the sharp fall in Sterling asset prices this week will mean more persistent inflation in an economy already struggling with prices rising at 10% a year. The large rise in Gilt yields will mean a larger proportion of taxes going to pay interest on the public debt, and less for schools and hospitals. Falling share prices mean investing becomes more expensive for British companies, and smaller retirement funds for those workers about to reach retirement. These are not jolly japes. These are very real, negative economic impacts.
In recent weeks economic institutions such as the Bank of England, the Treasury and the Office for Budget Responsibility have been criticised by MPs that are now in the Cabinet. This is not to say these institutions are above criticism, or resistant to change. They should be accountable for their performance. However, the sense from this “Mini Budget” was that it flies in the face of wise counsel, and has uncomfortable historical precedents from the early 1970s, and late 1980s. Both these episodes saw a short-term economic sugar rush end with a recessionary funk.
Managing a modern economy with relatively free movement of capital means a continuous dialogue with economic counterparties: investors, business leaders and workers. Governments build up a reservoir of trust and credibility. Recent years have seen this reservoir drained at a steady rate. There are now dangerous signs of it running dry.
Managing Director, Chief Economist