Top of mind –
Is the chaos in the UK Gilt market finally coming to an end?
Reversing the mini budget has significantly de-risked the fiscal trajectory for the UK in a short space of time.
The past few weeks in the UK have been tumultuous, with Downing Street’s fiscal decisions leading to extreme volatility in financial markets. Liz Truss may have resigned after only 44 days in office, but her policy’s impact on price movements in bond markets during those six weeks was unprecedented.
A Wild 44 days for Gilts
Source: Bloomberg 21 October 2022
UK gilt yields rose and fell an astonishing amount in such a short space of time, plunging the country’s fiscal credibility into question. Liz Truss’s successor, who will be announced in the coming days, has a lot to do: restore confidence in financial markets, tackle soaring inflation, control surging energy costs and spur growth.
Chancellor Jeremy Hunt’s reversal of the unfunded tax cuts in former Chancellor Kwasi Kwarteng’s mini budget, including shelving plans to cut the basic rate of income tax, keeping the corporation tax rate at 25% as opposed to the proposed 19%, and scaling back the energy support bill, seems to have restored some confidence.
Markets reacted before details of the policy reversal were unveiled - the pound rose more than 2% on the US dollar when reports came out that ministers were drawing up outlines on reversing the mini budget. UK government bonds also rallied, with 10-year yields falling from 4.45% to 4.05%, a welcome relief for the bond market.
Reversing the mini budget has significantly de-risked the fiscal trajectory for the UK in a short space of time. The UK’s long-term borrowing costs fell after Hunt’s statement. Gilt yields are still higher than they were before Kwarteng’s budget, but US 10-year bond yields have moved higher than their British counterparts, indicating the riskiness of the UK bonds has reduced.
Falling Riskiness of UK Debt
The chart above indicates the spread between UK and US government debt. When UK gilts move up, this shows a higher premium and the debt becomes relatively more expensive. After spiking earlier this month, the cost of the UK’s debt has come down and now trades at a discount compared with the US.
Source: Bloomberg 21 October 2022
The policy reversal also means the Bank of England should not need to raise interest rates as aggressively as anticipated under the previous fiscal expansion plans. This will be a welcome relief for homeowners across the country as mortgage rate increases may be more muted than expected.
But there is no such thing as a free lunch. On the flip side, we now have policies that provide less support to businesses and households through a much less fiscally stimulative policy. Energy bills will remain frozen for six months as opposed to two years. Consultants Cornwall Insight now expects average annual bills to reach £4,347.69 in April 2023. It forecasts prices may ease slightly by year-end but will remain well above the £1,277 cost a year ago. This will weigh on the growth outlook for the UK into 2023, which we anticipate will continue to be muted next year. While UK assets, namely government debt, corporate debt and equities are more attractively valued, we will likely see volatility in 2023 as we work through headwinds to achieve growth.