The UK pound hit a new 37-year low against the US dollar and UK government bonds sold off sharply on Friday as markets prepared for significant sales of UK debt securities to fund finance minister Kwasi Kwarteng’s proposed tax cuts and energy subsidies.
The yield on five-year UK bonds jumped as much as 51 basis points to 4.07%. The yield on 10-year gilts rose to hit 3.7%.
Sterling fell below $1.11 for the first time since 1985. At one stage the pound was down more than 3% to as low as $1.0897.
The FTSE 100 hit three-month lows as Kwarteng unveiled his historic tax cuts and spending plans to boost the economy — but hurt market sentiment as investors grow even more concerned about a huge increase in UK government borrowing.
The FTSE 100 closed down 2.0% at it lowest level since June 17, while the FTSE 250 also dropped 2.0% to hit near two-year lows.
The UK Debt Management Office (DMO) announced on Friday its Net Financing Requirement (NFR) for 2022-23 is rising by £72.4 billion to £234.1 billion following “the publication today of the Government’s Growth Plan.”
The DMO said the increase will be financed by additional gilt sales of £62.4 billion, taking the planned total in 2022-23 to £193.9 billion, and additional net sales of Treasury bills for debt management purposes of £10 billion, taking the planned increase in 2022-23 to £40.2 billion and the planned stock at end-March 2023 to £77 billion.
Traders said the extra gilt sales of £62.4 billion from the UK government might struggle because the UK central bank has announced it intends to reduce its stock of purchased UK government bonds by £80 billion over the next 12 months.
“Clearly the prospect of more debt-financed tax cuts is spooking gilt investors … it’s a perfect storm for gilts,” said Antoine Bouvet, senior rates strategist at ING.
Bouvet added: “This is an escalation of the dramatic sell-off we’ve already seen in the gilt market over the past two months …
“There are a lot of tax cuts coming on top of the energy price guarantee, and that’s scaring gilt investors who now see a tonne more issuance coming.”
Former US Treasury Secretary Lawrence Summers told Bloomberg Television: “It makes me very sorry to say, but I think the UK is behaving a bit like an emerging market turning itself into a submerging market …
“It would not surprise me if the pound eventually gets below a dollar, if the current policy path is maintained …
“This is simply not a moment for the kind of naïve, wishful thinking, supply-side economics that is being pursued in Britain …
“Between Brexit, how far the Bank of England got behind the curve, and now these fiscal policies, I think Britain will be remembered for having pursued the worst macroeconomic policies of any major country in a long time …”
REACTION:
Paul Johnson, Institute for Fiscal Studies (IFS) Director: “Today, the Chancellor announced the biggest package of tax cuts in 50 years without even a semblance of an effort to make the public finance numbers add up.
“Instead, the plan seems to be to borrow large sums at increasingly expensive rates, put government debt on an unsustainable rising path, and hope that we get better growth. This marks such a dramatic change in the direction of economic policy-making that some of the longer-serving cabinet ministers might be worried about getting whiplash.
“Mr Kwarteng has shown himself willing to gamble with fiscal sustainability in order to push through these huge tax cuts. He is willing to shrug off the risks of inflation, and to invite significantly higher interest rates. And he has avoided scrutiny by presenting a Budget in all but name without accompanying forecasts from the Office for Budget Responsibility.
“Injecting demand into this high-inflation economy leaves the government pulling in the exact opposite direction to the Bank of England, who are likely to raise rates in response. Early signs are that the markets – who will have to lend the money required to plug the gap in the government’s fiscal plans – aren’t impressed.
“This is worrying. Government borrowing is set on an upward path. It will reach its third-highest peak since the war, and remain at well over £100 billion, even once the energy support package is withdrawn.
“And we heard nothing on public spending. It seems almost inconceivable that plans made last year, when inflation was expected to peak around 3%, will not need topping up at some point, unless the government is willing to allow a (further) deterioration in the range and quality of public services. Presumably this government would borrow for that also.
“Mr Kwarteng is not just gambling on a new strategy, he is betting the house.”
Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown: “By throwing Rishi Sunak’s tax raising plans on a bonfire, the government is taking a big gamble that growth will be ignited, to help the economy grow.
“But confidence that these unfunded tax cuts are a coherent policy for today’s inflation laden times is going up in smoke, with the pound sliding to fresh 37-year lows against the dollar at $1.10 and government borrowing costs escalating.
“The yield on 10-year gilts rocketed to hit 3.7%, surging from 3.2% on Tuesday as investors demanded more return for the greater risk they were taking by buying government debt.
“Investors are betting that the Bank of England will dig in its heels further in its economic tug of war with the government and will go hard and fast with rate rises at the next two meetings. The markets are now expecting that the benchmark UK interest rate could jump to 5% by next summer, up from the higher predictions of 4.75% detailed by the Bank of England yesterday.
“The initial rosy glow which had shone on house builders earlier faded fast, as investors digested the implications that further UK interest rates are inevitable, given the government’s inflationary policies and would counteract the boost from a cut to stamp duty. It’s clear that the expected correction in house prices can’t be put off indefinitely as mortgage costs ramp up.
“Wealthy consumers are the biggest gainers in the tax bonfire, while lower earners will benefit the least and that has been greeted with a sigh of disappointment by investors in many retail and hospitality companies. Shares in the high street stalwart Next have fallen by 3.5% and JD Sports has fallen by more than 5% amid expectation that consumers will have to keep tightening their belts. Hospitality stocks are also on the slide, with no help in sight in terms of a cut to VAT to help companies weather the storm of the cost-of-living crisis.
“Although a higher interest rate environment would ordinarily be good for banks as it would boost net income margins (the money they make on loans), banking shares have also fallen back today. It’s not just the deteriorating economic outlook which has pushed down shares.
“The decision not to get rid of a corporation tax surcharge for the sector is considered a set-back. There had been high hopes that intense lobbying would see this go but the combined rate of tax on profits paid by banks and building societies will stay at 27%, and the lifting of the cap in bankers’ bonuses is small fry to what investors believe such a cut would have meant for the sector, when it comes to competitiveness over the longer term.”
Ben Laidler, Global Markets Strategist at social investment network, eToro: “Today’s emergency budget will be welcomed by plenty in the short term, especially higher earners, but it carries big risks if it fails to stabilise economic growth as the government hopes.
“It will worsen the UK’s already large 6% budget deficit and increase its near 100% debt/GDP level.
“Today’s plunge in both Sterling and bond prices clearly reflects this. The government is also increasingly pulling in the opposite direction to the Bank of England, which is raising interest rates to cool down the economy.
“There was nothing ‘mini’ about this budget announcement. Cuts to national insurance and the corporation tax were expected.
“The multiple surprises came from the big cuts to personal income taxes, with the lower rate dropped to 19% and the highest 45% level removed altogether. Cancellation of the coming alcohol duties rise was also unexpected and a belated recognition of the strong ‘beerflation’ pressures on the hospitality industry.
“We already saw what a stamp duty cut can do to the housing market during the pandemic, albeit this time around, there will be no specific end date that creates a mad buying rush.
“The outlook for the housing market has not been pretty in recent months, with the cost of living crunch and rising mortgage rates set to cause a slump. This duty cut will go some way towards tempering this.”
Alastair George, Chief Investment Strategist at investment research and consultancy firm Edison Group: “£45bn today and £100bn from the previously energy guarantee soon adds up to real money.
“It is probably somewhat churlish to blame today’s announcements for the decline in UK equities and sterling but investors have had a tough week following the hawkish FOMC meeting and markets are following the path of least resistance lower.
“With fiscal austerity discredited in the prior cycle, fiscal largesse in response to economic challenges – whether COVID-19 or the war in Ukraine – has become a growing theme.
“Unfortunately the debt will need to be paid back and now incurs higher interest rates. Injecting cash into the economy when labour markets are tight is pushing against what the Bank of England is trying to achieve, which will also confuse international investors in the UK.
“The first response is likely to be for the Bank of England’s rate trajectory to move upwards, with sterling’s fall looking increasingly disorderly. Unsurprisingly UK 2-year gilt yields have soared today to 3.9% on the UK Chancellor’s announcement.”
Nigel Green, CEO of financial advisory deVere Group: “The pound has plummeted to a fresh 37-year low against the dollar after the new Chancellor presented his mini-budget. UK government bonds, or gilts, also sold off dramatically; and the FTSE slumped.
“This is the markets giving a massive ‘thumbs down’ to Mr Kwarteng’s ‘growth plan’ for the UK economy through increased spending and tax cuts.
“The reaction reveals that investors don’t want to hold the pound as they think it will inflate, nor do they want gilts as they’re worried about government borrowing levels.
“The Chancellor may have refused to let the Office for Budget Responsibility – a government watchdog – release opinion and analysis about the mini-budget. But the markets have spoken – and they’re not impressed.”
James Richard Sproule, Chief Economist – UK at Handelsbanken: “There have been concerns about the affordability of these measures, the Government has set out that these measures will cost -£19Bln in 2022-23, and this rises to £45Bn in 2026-27.
“Gilt yields and interest rate expectations have been rising rapidly in response to the Chancellor’s statement. Sterling, already down and below its long term Purchasing Power Parity valuations, is seeing further falls.
“Interestingly the Government has also set out what it expects the energy package to cost, estimates from some analysts have been as high as £150Bln, although such estimates assume peak energy prices would continue for a prolonged period and that that consumers would not lower demand in the face of high costs.
“The Government’s own estimate as to the cost is some £31 Bln for households and £29 Bln for businesses in 2022-23. There is of course a good deal of uncertainty around these numbers due to energy prices themselves being so volatile.
“The Chancellor is still set to give a full budget in November of this year, and this will be accompanied by the Office for Budget Responsibility giving a full breakdown of the expected costs and impacts of the government decisions.”