Stuart Clark from Quilter Investors and Toscafund Asset Management’s Savvas Savouri debate the turbulent start to Liz Truss’s tenure as prime minister
Yes: Stuart Clark, portfolio manager at Quilter Investors
Ahead of the “mini” Budget, higher forward rate expectations were already an expected consequence of the fiscal easing associated with the energy price cap. The subsequent move to remove future tax increases, row back on the national insurance increase and end the additional rate income tax bracket, while maintaining expenditure, led to an immediate reassessment of the outlook for the UK.
Even with the reversal on the 45 per cent income tax rate, this is still a largely unfunded and stimulative set of policies that will require further, or elongated, tightening from the Bank of England.
While it is true that many of the policies had been pre-disclosed, the magnitude, open-ended nature of some and the lack of OBR (Office for Budget Responsibility) forecasts, has significantly dented the credibility of the new government. In an environment where we see CEOs and central bankers criticised for mismanagement of communications and needing to rebuild trust over a significant period, it seems reasonable to assume a similar period will be required for this government and its policies.
In the meantime, if there is a greater degree of uncertainty then it is reasonable to expect external investors to demand a higher expected return – an outcome which was seen immediately in the gilt market.
Another significant policy announced was to adjust the stamp duty thresholds for home purchases. As we have seen in the past, these changes tend to see further house price inflation and arguably benefit sellers, failing to improve the affordability of UK housing for first time buyers. Further, the higher interest rates and the impact on mortgage rates from any increased tightening will arguably make property significantly less affordable for those joining the property ladder or having to remortgage at this point in time. This ultimately could cause some severe turbulence in the housing market.
With respect to the reversal of future corporate tax rate increases, it is hard to argue that it is solely the taxation system that has led to pay constraint. Indeed, we can look at the differential between public sector pay settlements and the private sector in recent times to understand that it is not necessarily taxation, but the employers’ views on differing stakeholders that has a material impact on the ability of employees to participate in the growth of an economy.
While the reversal on additional rate tax is an absolute political requirement, given the market response, the net impact on lower earners’ available income remains negative. It is argued that there is a well-known higher marginal propensity to consume if you increase the income of lower earners versus increasing that of the wealthy. Such an increase in the income of lower earners, if it occurred, would help mitigate against fuel and food poverty so many are enduring at this time.
Instead, the government has focused on increasing the wealth of and ability to save and or invest, in a tax efficient manner for those that already have surplus capital.
Whatever spin is placed on the announcements, they were significantly biased towards higher earners and corporations and rely on a trickle-down effect. The timing differential between this trickle down and the immediacy of the cost-of-living crisis does not help with the immediate outlook for the UK economy and consumer confidence. We now need to wait and see how the chancellor believes he can balance the books without further expanding the level of social and wealth inequality.
No: Savvas Savouri, chief economist at Toscafund Asset Management
The UK has a new prime minister in Liz Truss and a new chancellor in Kwasi Kwarteng. To say they face immense challenges is no exaggeration. Then again, challenges abound across Europe, Mena, and, no less, the US. Against such a chilling backdrop, the economic problems building within the UK are exacerbated by economic troubles beyond it.
With well-reported clouds darkening over the UK, let me reflect on forces that might shed some sunlight. For one, the reshoring of manufacturing to the UK is underway. This is being propelled, not merely because sterling is sitting at its current low levels – albeit less low following the prime minister’s taxi U-turn – but because of efforts to bolster supply-security.
Another ray of sunshine is that however much Ms Truss tries to go cold on China, its rapidly growing affluent class can only continue warming to all things British. And, be in no doubt, whatever challenges China faces, Beijing has the monetary and fiscal firepower to fix things.
We also must consider some positive fallout from the economic and political shocks that are certain to hit continental Europe, including the return of many hundreds of thousands of EU nationals who evacuated the UK when Covid struck. The reality is, in being so focused on ‘our’ problems, we miss the fact that living costs and interest rates are moving sharply higher across large tracts of Europe. Indeed, the escalation in UK pay awards will encourage those who once worked here to return and encourage those here who stepped out of the labour market to become economically active again.
For all the cost hikes hitting UK households, throughout the coronavirus period in aggregate these were flooded with cash; data for which the Bank of England has chosen to ignore in its dire economic forecasting. While moves higher in the base rate, and along the yield curve generally, will tighten monetary conditions, a weaker pound will in part counter this.
As for those mortgaged homeowners being “sorely-hit” by higher interest rates, this impact will be part absorbed by the prevalence of fixed-rate deals, and many years where an ultra-low base rate allowed for the fastest deleveraging in the history of UK home ownership. As for concerns over what damage the disorderly sell-off in gilts and sterling post the “mini” Budget could inflict on the UK economy in the long term, my reply is this: while the dollar may be flying now, it and the US Treasury market have a hard landing coming. When these crashes happen, sterling and gilts will not be co-casualties, but beneficiaries.
So, while we can compare 2022 to 1979 and 1989 as much we like, the UK economy is nothing like it was back when recessions struck in those years. The forecasts for the years ahead from the IMF, the Bank of England, and many others will, in time, prove deeply misguided.
The weakness we have witnessed in the FTSE 250 – a barometer of investor sentiment towards the UK – can be interpreted in two different ways. It could be argued that what we have seen is the market forward-pricing the lengthy recession the BoE confidently predicts the UK will sink into. However, what if what we have witnessed is an illustration of how market participants are lemming-like? Some will remember the FTSE250 sell-off in the aftermath of the Brexit referendum, and indeed the rally recorded once it became clear the BoE’s “Project Fear” was bunkum.
Going back further, we note that once fears of a “Triple-Dip” that had overhung sentiment until early 2013 had been lifted, so too was the FTSE 250. Each time the market has been “oversold”, we have witnessed it become all the more attractively cheap for buyers – invariably from overseas – looking to capitalise.
To see just how cheap the UK is now, one need only look at the stampede of US private equity firms to “buy British”. The smart thing to do is not buy the nonsense the BoE is selling but acquire domestically exposed UK equities.
