U.K. financial markets barely moved after Chancellor Jeremy Hunt’s Autumn Statement last Thursday, in which a substantial fiscal tightening of around 2% of GDP was announced to fill a £55bn ‘black hole’ in public finances. The calm reflects the welcome lack of surprises after a month of off-the-record press briefings by government officials.
Investors in sterling, gilts and U.K. stocks were being given a massage: that the adults are back in the room.
Reassuringly, the statement came with an accompanying analysis from the Office of Budget Responsibility (OBR) and with supportive references to the Bank of England. Two independent institutions were deliberately side-lined by the Truss/ Kwarteng government when preparing their ill-fated September budget (which reflected a distrust of experts, a common theme on the populist right).
Furthermore, the statement was delivered without the smirks and crowing from the Conservative front bench that characterised the September budget.
This is not to say it the budget was not political. One example is the decision to keep the ‘triple lock’ on the state pension. This means inflation-linked pay rises of around 10% for the country’s pensioners, while wages are rising at, on average, 6%, and public sector workers less. The Conservative Party gets its vote primarily from the over-65s.
The most glaring political feature is the delay in implementing public spending cuts until after the 2024 general election. This will leave the next (probably Labour) government to sack the same public sector workers that vote for the party. Indeed, there will be a slight increase in the budget deficit ahead of the election as new money is found for health and education.
The government argues that the reason for delaying the public spending cuts is that the measures may not be needed if economic growth proves stronger than forecasted.
Investors can handle complexity but not moronic policy
Another explanation for the market’s stability is that investors deal with several inter-connecting macro-economic themes when they buy an asset, whether it be gilt, sterling or U.K. stocks. This brings complexity and nuance.
For example, fiscal austerity from 2024 will hasten the demise of inflation (everything else being equal). This should reduce the long-term outlook for interest rates, which is good news for gilts.
But owners of risk assets, such as equities, credit, and mortgaged property, will also benefit from reduced long-term borrowing costs, even as recession hurts sales and income statements.
If sound government finances emerge from this budget, there is a greater chance of financial stability returning to the U.K., encouraging investment and supporting growth.
Sterling looks like it will remain weak because of the weak domestic growth outlook and an increasing gap between U.K. and U.S. interest rates. But there is a reduced risk of parity in the GBP/USD exchange rate if the government can continue to reassure foreign owners of gilts that the deficit problem is being addressed. The selling of gilts by foreigners led to the lurch in sterling in late September.
Investors can not cope with bad policies driven more by ideology than by evidence. The essence of ‘Trussonomics’ was on display in the September budget. This is what the bond market had dubbed ‘the moron premium’, which led to the dramatic selloff of gilts and sterling.
Fortunately for investors, the government has made a 180-degree turn and now embraces economic orthodoxy and the institutions that help support it.
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