ALEX BRUMMER: Often forgotten is that as Thatcherite reforms took hold, sterling was back at $2 level by 1990 – in world of foreign exchange, nothing is forever
Forgotten: As Margaret Thatcher’s reforms took hold, sterling was back at $2 level by 1990
There should be no surprise that financial markets have taken Kwasi Kwarteng’s fiscal event badly. The pound, which has sagged since Boris Johnson was ejected from Downing Street, is suffering from political instability, according to traders.
Britain has a reputation for fiscal discipline, so the choice of Liz Truss’s government to loosen the purse strings unsettled sterling and gilts.
There are no formal numbers on the impact on the public finances but number-crunchers at the National Institute of Economic and Social Research argue that higher spending (largely on rescuing the energy market) and tax cuts will increase the Government deficit by as much as £150billion.
That would take UK government debt as a percentage of national output to 91.6 per cent in 2024-25 – against a projected drop to 87.6 per cent of GDP.
This might fuel the narrative of doomsters but it is worth remembering that at such levels it is a substantially lesser debt burden than that of the US, Japan and Italy, which are all up in the stratosphere. It is also lower than France, which has an economy that is not that dissimilar in size and structure to our own.
As a freely floating major currency, sterling has been an easy ride for speculators during a period of uncertainty. Clearly, no one wants to see the pound trading at $1.08, where it is close to 1985 lows.
What is often forgotten though, is that as Thatcherite reforms took hold, sterling was back at the $2 level by 1990. In the world of foreign exchange, nothing is forever.
Traders argue that Britain has become politically unstable since the Brexit referendum of 2016. Yes, there have been four Prime Ministers. But they are all of the same party, which was elected with an 80- seat majority in 2019. Contrast this for instance with Italy and Sweden, where neo-fascist parties have or will soon have a role in government, and France, where the extreme right has 89 seats in the National Assembly.
That’s something markets should really worry about.
British funding needs will rocket in the coming months. The Debt Management Office has the daunting task of raising an extra £72.4billion in the current fiscal year.
This at a time when the Bank of England is planning to sell down £80billion of its £900bn of quantitative easing holdings over the next 12 months.
At the start of the summer, when Boris Johnson was on the ropes, the yield on the two-year gilt was 1.7 per cent. Before Kwarteng’s event, the yield was 3.4 per cent and in latest trading it had reached 3.9 per cent.
How worried should we be?
The death of Queen Elizabeth II brought hundreds of world leaders to London. Among those present were many Gulf rulers who have been long on British bonds and property, and remain backers.
Norwegian oil wealth funds have preferred London to their Nordic neighbours and at current levels, UK bonds should start to look more attractive to the less sticky investors.
One thing is certain: with inflation at or close to double digits, Kwarteng should not be following the example of predecessors and signing off on more index-linked bonds. Tying 25 per cent of Britain’s debt to retail prices was a first-order blunder.
The Chancellor’s mini-Budget wasn’t quite the ‘Big Bang 2.0’ predicted, but the direction of travel is clear.
Instead of hiding away the lifting of the cap on bankers’ bonuses in the small print, Kwarteng refreshingly sought to make a virtue of it.
Being able to lift the cap is a Brexit dividend. As much as one may abhor ‘fat cat’ bonuses, the freedom to set awards for performance will fuel the prosperity of the Square Mile and Canary Wharf.
It will also pay down the debt as financial services are a rich source of tax revenue, helping fund the NHS and welfare.
Similarly, the decision to make it easier for pension funds to invest in illiquid assets, such as infrastructure and start-ups, should be positive.
Less attractive is the notion that the funds could also pile more money into private equity.
The returns may be attractive. But the destructive power of private equity, as seen in care homes, retail and defence industries, such as aerospace pioneer Cobham, outweighs any benefit.