New UK Chancellor Jeremy Hunt has scrapped basic income tax cuts that were proposed last month. AFP.
New UK Chancellor Jeremy Hunt withdrew most of last month’s ‘mini-budget’ tax cuts and also limited energy bill freezes. The U-turn has helped calm markets but we remain cautious.
The government has now unwound GBP32 billion of its GBP45 billion of tax cuts. But the budget may need to be tightened by a further GBP40 billion to stabilise the UK’s finances.
The Bank of England will need to hike 100bps in November to regain credibility and, third, the UK may suffer a long recession now.
We stay GBP bears despite its rally from record lows of 1.03 against the USD last month to 1.13. The fiscal shock will make it harder for the UK to attract capital without a cheaper currency.
New UK Chancellor Jeremy Hunt has scrapped basic income tax cuts that were proposed last month. AFP.
The GBP and UK government bonds (gilts) rallied after new Chancellor Hunt withdrew last month’s ‘mini-budget’ tax cuts, except for national insurance and stamp duty, and said energy bill freezes would be reviewed in six months’ time.
The major U-turn has helped calm financial markets by showing the new finance minister seeks stable public finances and will rein in government borrowing. The chart shows GBP has recovered to 1.13 against the USD after hitting an all-time low of 1.03 last month while 10Y gilt yields have declined from 4.63% to under 4.00%. Despite, the welcome U-turn, however, we stay cautious on the outlook for UK assets and GBP.
Firstly, the budget may need to be tightened by a further GBP40 billion to stabilise the UK’s finances.
The government has now unwound GBP32 billion of the GBP45 billion of tax cuts in the ‘mini-budget’. But UK media reports the independent Office for Budget Responsibility (OBR) is now forecasting GBP72 billion of tax rises or spending cuts will be needed to stabilise the government’s debt relative to GDP. UK gilt yields remain higher than before the ‘mini-budget’ while freezing energy bills even if time limited will still cost the government GBP60 billion for the next six months.
Secondly, the weaker GBP has increased inflation fears. But the spike in gilt yields after the ‘mini-budget’ forced the Bank of England to intervene for two weeks to buy gilts to stop pension funds failing. To regain credibility, we expect the BoE will need to increase its Bank Rate by 100 basis points (bps) at its November meeting from 2.25% to curb double digit inflation as shown in the chart above.
Thirdly, the energy shock from the Ukraine war and the fiscal shock from the ‘mini-budget’ will cause recession. We see UK’s GDP shrinking 0.8% in 2023.
We thus stay GBP bears. The UK budget deficit is still likely to exceed 5% of GDP this year while the current account deficit is a huge 8% of GDP. Though Hunt’s actions have removed the immediate risk of further GBP plunges, the blow to stability from the ‘mini-budget’ will make it harder for the UK to attract capital without a cheaper currency to compensate investors. We forecast the GBP will fall back towards its all-time lows against the USD over the next few months.
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