UK credibility 'still damaged' despite 45p tax rate U-turn
Chancellor Kwasi Kwarteng’s U-turn on the 45p tax rate does little to quell investor concerns about the UK, traders and economists say.
With sterling losing some of its earlier surge, William Marsters of Saxo UK, warns that the government’s credibility is still damaged:
“The rally in sterling up to 1.1281 versus the dollar has already pulled back to below the 1.12 level, highlighting it was a low-level relief.
The move to reverse the tax cut decision won’t add much to the government’s balance sheet and so will be seen more as a signal to investors than anything else.
As far as government credibility goes, investor concern might be more focused around the government’s disconnect internally with Prime Minister Truss saying the top-tier tax cut decision was made by Chancellor Kwarteng, and other cabinet members were not consulted on the matter.”
George Lagarias, chief economist at audit, accounting and consulting group Mazars, also warns that international investors are wary of UK assets:
“The Chancellor’s forced U-turn should take some pressure off the Pound, for the time being.
Still, the UK has lost some credibility with international markets over the past few years. Despite the Pound’s currency reserve status, British risk assets have a long and difficult way before they return as a staple in the portfolios of international long-term investors.“
Bethany Payne, global bonds portfolio manager at Janus Henderson Investors, warns the pound may remain ‘unloved’ for some time:
“In spite of a significant U-turn from the Chancellor, the currency moves have been fairly minor with sterling trading at similar levels to where it was on Friday and still just below the levels prior to the mini budget.
Meanwhile the Bank of England is in crisis talks with regulators to provide a more medium-term solution to backstopping pension fund strategies to prevent a repeat of last week’s market movements. The Bank of England has so far delayed the date of their own gilts sales to 31 October, in effect giving them and the government a four-week window for resolution.
While authorities dash to save the long-end of the bond market, Sterling still remains under its own unique pressures and we expect it to remain unloved for some time.”
Britain’s credibility in the financial markets remains weak following the mini-budget, traders and economists have warned.
Chancellor Kwasi Kwarteng’s humiliating u-turn on his plan to scrap the highest rate of income tax (45p on those earning over £150,00) has given UK assets a lift, after a week of market turmoil
The pound has gained over a cent to above $1.13 recovering its losses since Kwarteng’s unfunded tax cuts spooked markets. It’s also up a eurocent at €1.15, for the first time since just before the mini-budget.
UK short and medium-term government bonds have recovered some losses too, with the yield on 10-year UK gilts back below 4%.
Charles Hepworth, investment director at GAM Investments, warned:
When market trust has been shattered, as we saw last week, the uphill task of restoring credibility is extremely hard and even harder when strategies shift.
The market currently has little faith that the Prime Minister and Chancellor can restore credibility in the short term, and this puts further renewed pressure on UK risk assets.”
That suggests significant cuts to spending – or further u-turns – are likely to be announced in November.
The ResolutionFoundation calculated that top earners are still the main winners from the mini-budget, even though they have now lost much of the benefits.
Here’s an explainer about what the latest developments mean::
And here’s Larry Elliott on the unnecessary harm caused by an already weak UK economy:
September’s PMI report suggests that the sector is already in a recession, says Thomas Pugh, economist at RSM UK:
The surge in borrowing costs will reduce investment and employment over the next year as firms cut back on non-essential spend in order to finance debts. As a result, the manufacturing sector is likely to remain in a downturn well into 2023.
The only silver lining is that the recent sharp fall in global commodity prices should start to feed through into lower input costs for manufacturing firms. However, the outlook for energy prices once the government’s six month cap expires will be crucial in determining the fate of the sector.’
Growth also slowed at US factories, while eurozone manufacturers also suffered another contraction as the energy crisis hit demand and drove up costs.
The oil price has jumped, on speculation that the Opec+ group could cut production by over a million barrels per day.
Thames Water, Southern Water and other companies will be forced to cut tens of millions of pounds from consumers’ bills after the regulator said they had missed pollution targets.
Vodafone and the owner of Three UK are in talks about a potential merger that would create Britain’s biggest mobile operator.
And Kim Kardashian has paid US regulators more than $1m to settle charges for failing to disclose that she was paid to promote a crypto asset in a post on her Instagram page.
Our Politics Live blog has all the latest action from the Conservative Party conference:
Barely a week after spooking the financial markets with a spectacularly badly-received mini-budget, and just hours after a humiliating u-turn on his tax cut for top earnings, KwasiKwarteng has told the Conservative Party conference that his economic deal will be backed with an ‘iron-clad commitment’ to fiscal discipline.
Kwarteng also promised to focus relentlessly on growth, and lay out details of his plan to bring down public debt as a share of GDP shortly [it’s scheduled for 23rd November].
Kwarteng also tried to brush aside the opposition to his plans, saying they had ‘caused a litle turbulence’. Tell that to people facing a larger increase in mortgage costs next year….
On the upside, the markets were little-moved by Kwarteng’s speech – which probably counts as a win.
In another sign that the global economy is slowing, US manufacturing activity grew at its slowest pace in nearly two and a half years in September.
The latest survey of purchasing managers from the Institute of Supply Management found that new orders contracted, as demand for goods was hit by rising interest rates.
The ISM’s manufacturing PMI dropped to 50.9 this month, the lowest reading since May 2020, from 52.8 in August. That’s closer to the 50-point mark showing stagnation.
The report also found that prices were increasing at a slower rate, which may be a sign that the surge in US inflation is abating.
But with employment levels also contracting, and exports down, it adds to evidence of a slowdown.
The decision to keep the 45p tax band for the highest earners may not protect the UK from a credit rating downgrade.
Credit rating agency S&P Global says the U-turn won’t have a material impact on its latest projections for the UK economy.
S&P rating analyst Maxim Rybnikov said.
“We consider that the decision to reverse the tax cuts for highest earners is not going to materially affect our fiscal and economic projections for the UK that we published last Friday.”
“We will continue to monitor government announcements, including possible future fiscal consolidation measures, and assess their impact on our negative outlook.”
Last Friday, S&P lowered its outlook on the UK’s AA sovereign credit rating to “negative” from “stable,” citing concerns about the country’s fiscal outlook and the ‘additional risks’ in lending to the UK.
It also estimated the UK budget deficit will widen by an average 2.6% of gross domestic product per year to 2025, due to the mini-budget measures.
The agency also warned that net general government debt will continue on an upward trajectory, “in contrast to our previous expectation of it declining as a percentage of GDP from 2023.”
Traders are betting it will take a bigger UK government policy U-turn to restore credibility with markets, reports Bloomberg:
The problem for investors is that the rest of the recent mini-budget, including borrowing billions to fund energy price caps and other tax cuts, is still going ahead, hurting the country’s debt sustainability. While the U-turn may slightly improve that outlook, it also damages the credibility of a government facing a revolt in its own party and a collapse in support in voter polls.
“The U-turn represents a concerted effort to soften the narrative regarding the government’s economic agenda but little to change the direction,” said Neil Mehta, a portfolio manager at BlueBay Asset Management.
“This dynamic should support the pound in the short-term, but we think this will be short-lived, as confidence in the government is shot and policies come home to roost over a difficult winter for the UK economy.”