ALEX BRUMMER: It’s often forgotten that when the Thatcherite reforms took hold, the pound was back to the $2 level in 1990 – in the forex world, nothing is forever
Forgotten: As Margaret Thatcher’s reforms took hold, the pound was back at the $2 level in 1990
It should come as no surprise that financial markets took the Kwasi Kwarteng fiscal event badly. The pound, which has slumped since Boris Johnson was ejected from Downing Street, is suffering from political instability, traders say.
Britain is known for its fiscal discipline, so the Liz Truss government’s choice to loosen the purse strings has destabilized the pound and the gilts.
There are no official figures on the impact on public finances, but specialists from the National Institute for Economic and Social Research say that higher spending (largely to save the energy market) and tax cuts will increase the public deficit by up to £150 billion.
This would take UK public debt as a percentage of national output to 91.6% in 2024-25, from a projected decline to 87.6% of GDP.
This might fuel the catastrophists’ narrative, but it’s worth remembering that at such levels the debt burden is significantly lower than that of the United States, Japan and Italy, all of which are in the stratosphere. It is also lower than that of France, whose economy is not so different from ours in size and structure.
As a free-floating major currency, the British pound has been an easy ride for speculators during a time of uncertainty. Clearly, no one wants to see the pound trading at $1.08, when it’s near the 1985 lows.
What is often forgotten, however, is that when the Thatcherite reforms took hold, the pound was back to the $2 level in 1990. In the world of foreign exchange, nothing is forever.
Traders say Britain has become politically unstable since the 2016 Brexit referendum. Yes, there have been four prime ministers. But they are all from the same party, which was elected with a majority of 80 seats in 2019. Compare this for example with Italy and Sweden, where neo-fascist parties have or will soon have a role in government, and the France, where the far right has 89 seats in the National Assembly.
This is something the markets should really be concerned about.
British financing needs will explode in the coming months. The Debt Management Office has the daunting task of raising another £72.4 billion in the current financial year.
This comes at a time when the Bank of England plans to sell £80bn of its £900bn in quantitative easing holdings over the next 12 months.
At the start of the summer, when Boris Johnson was on the ropes, the two-year gilt yield was 1.7%. Prior to the Kwarteng event, the yield was 3.4% and in recent trades it had risen to 3.9%.
How worried should we be?
The death of Queen Elizabeth II brought hundreds of world leaders to London. Among those present were many Gulf leaders who have long been on British bonds and property and who remain backers.
Norwegian oil funds have favored London over their Nordic neighbors and, at current levels, UK bonds should start to look more attractive to less sticky investors.
One thing is certain: with inflation at or near double digits, Kwarteng is unlikely to follow the example of its predecessors and sign more indexed bonds. Tying 25% of UK debt to retail prices was a major mistake.
The Chancellor’s mini-budget wasn’t quite the ‘Big Bang 2.0’ predicted, but the direction of travel is clear.
Instead of hiding the lifting of the bankers’ bonus cap in fine print, Kwarteng sought to turn it into a refreshing virtue.
Being able to lift the cap is a Brexit dividend. While fat cat bonuses may be loathed, the freedom to set rewards for performance will fuel the prosperity of the Square Mile and Canary Wharf.
It will also pay down debt as financial services are a rich source of tax revenue, helping to fund the NHS and social care.
Likewise, the move to make it easier for pension funds to invest in illiquid assets, such as infrastructure and start-ups, should be positive.
Less appealing is the idea that the funds could also invest more money in private equity.
Returns can be attractive. But the destructive power of private equity, as seen in nursing homes, retail and defense industries like aerospace pioneer Cobham, outweighs any benefit.