Please see the below article from Brewin Dolphin, which takes a look at the new Chancellors reversal of last month’s ‘mini-budget’ and the impact of this on the market. This was received late Monday afternoon – 17/10/2022.
UK chancellor Jeremy Hunt has announced a reversal of almost all the tax-cutting measures contained in last month’s mini-budget. Guy Foster, our Chief Strategist, highlights the key announcements and how markets are responding.
On his first full working day as the new UK chancellor, Jeremy Hunt has overturned nearly all of his predecessor’s tax-cutting proposals. In an emergency statement, Hunt said the government was committed to doing whatever necessary to achieve UK financial stability and put the public finances on a sustainable path.
The statement was not only about further plugging the gap in the government’s fiscal plans, but also restoring the UK’s economic credibility after the turmoil created by September’s mini-budget.
Here, we highlight the main measures and the impact on financial markets.
Key measures
Hunt announced that the planned reduction in basic-rate income tax will no longer go ahead in April. Instead, the rate will remain at 20% “indefinitely” until the economic circumstances allow it to be cut.
The new chancellor also overturned Kwasi Kwarteng’s plan to reverse the 1.25 percentage point rise in the rate of dividend tax. The rate of dividend tax increased in April 2022 to 8.75% for basic-rate taxpayers, 33.75% for higher-rate taxpayers and 39.35% for additional-rate taxpayers1. Today’s announcement means these rates will remain in place rather than fall next year.
Plans to freeze alcohol duty, introduce VAT-free shopping for tourists and reverse off-payroll working rules have also been axed. Together with the corporation tax U-turn and the decision to scrap proposals to axe additional rate income tax, the changes are expected to save the Treasury around £32bn a year2. And while energy support for households will not change between now and April, beyond that it will depend on the outcome of a Treasury-led review rather than stay in place for a further 18 months.
The only tax-cutting measures from the mini-budget that haven’t been axed are those that are already going through parliament – namely, the reform to stamp duty and the reversal of the 1.25 percentage point National Insurance (NI) rate hike. Reforms to stamp duty came into effect on the same day as the mini-budget, and the rate of NI will reduce from 6 November.
How are markets reacting?
Sterling extended its early morning gains against the US dollar and the yield on UK government bonds (gilts) fell following the statement, suggesting financial markets are so far welcoming the changes.
The decline in bond yields means government borrowing is less expensive. The things financial markets worry about the most are the ability of a country to pay interest, the potential for more debt to be issued in the future (which weighs on the price of existing debt) and to maintain the value of its currency. If any of these things are in doubt, financial markets will feel less inclined to hold gilts and less inclined to hold the pound, unless they can be compensated by higher interest rates. Those higher interest rates end up being suffered each time the government issues a new bond and will last for as long as that bond lasts (some bonds borrow money over a few years, whereas others borrow over several decades).
Ultimately, government expenditure must be met from taxes or borrowing. If it is met from borrowing, this debt will have to be repaid and so will the interest on that debt which, in turn, will have to be borrowed or paid from taxation.
If the market starts charging the government more over the coming years, then it will affect interest rates for other kinds of borrowing as well. The most obvious example of this is mortgage rates.
Will borrowing costs fall further?
Borrowing costs for governments rose throughout this year, reflecting the return of inflation and the prospect of higher interest rates to try and bring that inflation down. From the beginning of August onwards, borrowing costs in the UK rose a bit more than in its international peers, which likely reflected anxiety over promises being made to cut taxes and increase spending. These fears were amplified by the mini-budget.
While we have seen some improvement in borrowing costs, there is still further to go. Even accounting for the general increase in global borrowing costs, UK bond yields were still higher than they were in July, when the Conservative Party leadership contest began to narrow. This, however, has been changing fast.
Markets have been highly volatile, but one silver lining has been improved buying opportunities in the UK government bond market. Gilt prices move in the opposite direction to yields, so the recent sharp rise in yields has seen the prices of some longer-dated gilts fall substantially. Gilt prices are expected to stabilise as the market starts to anticipate the onset of a recession, and they could rise if held until redemption.
Inflation-protected (index-linked) bonds, where the redemption amount and the interest rise with inflation, now offer positive returns which are comparable with the rates offered by other savings instruments and they can also be very tax efficient.
Is further volatility on the cards?
The chancellor is due to deliver a medium-term fiscal plan on 31 October. This will contain the government’s fiscal rules and a forecast by the Office for Budget Responsibility. The experience of his predecessor means Hunt will likely be careful not to spook the markets at Halloween.
In the meantime, UK inflation data due out this week will serve as a reminder that not all challenges can be walked away from as the mini-budget has been.
The UK bond market is very responsive to changes in the UK economy, but the equity market is typically more global or even US-centric in nature, so being too absorbed in domestic challenges has never served UK investors well.
Nevertheless, today’s statement has shown how the UK’s institutions will step in when policymaking is shown to be unsustainable. That may offer investors a degree of confidence in what has been a truly tumultuous month for UK financial assets.
1 https://www.gov.uk/tax-on-dividends
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Cyran Dorman
18th October