New UK Chancellor, Kwasi Karteng, announced a sweeping set of tax cuts in his Mini-Budget, including cuts to income tax, national insurance, corporation tax and stamp duty. This means lower receipts of taxes for the Treasury. Meanwhile, the energy price freeze will certainly help to control inflation and help with household bills but it comes at a colossal cost. So, at its simplest level, the Mini-Budget means that the Treasury will have less money coming in and more money going out.
According to Paul Johnson, Director at the Institute for Fiscal Studies, this is: “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 huge increase to the budget deficit means the government will undoubtedly be borrowing vast sums from the financial market in the near term. But without any tangible plan for generating growth, lending to the UK is seen as being riskier than it was. And that is reflected in a substantially higher borrowing cost (or interest rate) for the UK government debt and reflected in a sharp fall in the value of sterling.
The twin deficit (the budget deficit from government spending and the current account deficit from the UK being a net importer) currently sits at over £250 billion. This is a huge amount of capital that needs to be found every year (through debt issuance and foreign investment into the UK). This might be okay in normal times, but when growth is weak and economic uncertainty is high, it is deeply problematic. With mounting reasons not to invest in the UK, this funding gap is becoming ever harder to fill.
The UK government and Bank of England may need to step in to avoid another sterling crisis.
What does it mean for your investments?
We operate within a global market and so the majority of your portfolios (about 60% for a balanced portfolio) are invested in assets outside the UK and so those assets are denominated in foreign currencies (mainly the US dollar). The drop in the value of sterling means those assets denominated in foreign currency are worth more in sterling than before. The fundamental value of them hasn’t changed. So, in a big sense, it’s business as usual for your portfolio.
Although we do have some exposure to UK companies. For the most part, these are large multinational companies with plenty of foreign revenue. So, if anything, the tax cuts will benefit them to some degree. It is the smaller companies that face the domestic UK economy that are likely to face the greatest challenge from a weak domestic economy, the rise in borrowing costs and the drop in sterling making any imports substantially more expensive. Our exposure to this part of the UK market was reduced in August.
Finally, we are not invested in any UK government debt directly and our exposure indirectly is not significant.
