ALEX BRUMMER: It’s often forgotten that when Thatcher’s reforms took hold, the British pound was back at the $2 level in 1990; In the world of forex, nothing is forever.
Forgotten: When Margaret Thatcher’s reforms took hold, the British pound returned to the $2 level in 1990
It should come as no surprise that financial markets have taken the Kwasi Kwarteng fiscal event poorly. The pound, which has fallen since Boris Johnson was ousted from Downing Street, is suffering from political instability, according to traders.
Britain has a reputation for fiscal discipline, so the Liz Truss government’s decision to loosen the stock market unsettled sterling and gilts.
There are no formal numbers on the impact on public finances, but numbers experts at the National Institute for Economic and Social Research argue that more spending (largely on energy market bailouts) and tax cuts will increase the government deficit up to £150bn.
That would take UK government debt as a percentage of national output to 91.6% in 2024-25, against a projected drop to 87.6% of GDP.
This could fuel the doomster narrative, but it’s worth remembering that at such levels it’s a substantially lower debt load than the US, Japan and Italy, which are all in the stratosphere. It is also lower than France, which has an economy that is not that different in size and structure from ours.
As a free-floating major currency, the British pound has been an easy ride for speculators during a period of uncertainty. Clearly no one wants the pound to trade at $1.08, where it is near 1985 lows.
What is often forgotten, however, is that when Thatcher’s reforms took hold, sterling returned to the $2 level in 1990. In the world of currencies, nothing is forever.
Traders argue that 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 an 80-seat majority in 2019. Compare this, for example, with Italy and Sweden, where neo-fascist parties have or will soon have a role in government, and France, where the La The far right has 89 seats in the National Assembly.
That is something the markets should really be concerned about.
British financing needs will skyrocket in the coming months. The Office of Debt Management has the daunting task of raising an additional £72.4bn in the current financial year.
This at a time when the Bank of England plans to sell £80bn of its £900bn in QE assets over the next 12 months.
At the start of the summer, when Boris Johnson was on the ropes, the return on two-year-old gilts was 1.7 percent. Before the Kwarteng event, the return was 3.4 percent and in recent trading it had reached 3.9 percent.
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 long been with British bonds and properties, and remain patrons.
Norwegian oil funds have preferred London to its Nordic neighbors and at current levels UK bonds should start to look more attractive to less rigid investors.
One thing is for sure: With inflation in or near double digits, Kwarteng should not follow the example of his predecessors and sign more index-linked bonds. Tying 25 per cent of Britain’s debt to retail prices was a mistake of the first order.
The Chancellor’s mini-budget was not exactly the ‘Big Bang 2.0’ envisioned, but the direction to follow is clear.
Instead of hiding the lifting of the cap on bankers’ bonuses in the fine print, Kwarteng tried 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 performance rewards will boost the prosperity of Square Mile and Canary Wharf.
It will also pay off debt, as financial services are a rich source of tax revenue, helping to 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 a positive one.
Less appealing is the idea that the funds could also accumulate more money in private equity.
The returns can be attractive. But the destructive power of private capital, as seen in nursing homes, retail and defense industries like aerospace pioneer Cobham, outweighs any benefits.