October 21, 2022

News in Charts: The degrowth impact of a (discarded) growth plan

by Fathom Consulting.

On 23 September the UK’s then new, now previous, Conservative administration presented a ‘mini-budget’ with £45 billion in proposed tax cuts aimed at sparking growth in the UK economy. The mini-budget was not well received by investors because there was neither a mention of how these cuts would be funded nor an assessment of the plan by the UK’s independent Office for Budgetary Responsibility. Fast forward to today past recent market turmoil, and the mini-budget is no more. The U-turn and the upcoming leadership change do not mean that the problem is solved, however. As Brian Davidson explained in a recent Fathom Consulting Viewpoint, the UK government’s plan for growth ended up creating de-growth even without being implemented.

Liz Truss was right to frame productivity growth as the UK’s chronic economic woe but focusing on that at a time when the main concern is inflation backfired. The controversial or rather untimely argument can be summarised as: investments must be made, preferably private, to spark productivity growth. Indeed, UK business investment as a share of GDP has been low, and dropped below 10% post-EU-referendum, whereas Germany’s, for example, rose to around 12% at its latest read. But how can you push the needle up on something that seemingly exhibits a strong downward trajectory after the referendum? The government went for something unconventional and chose inflation-friendly cuts in corporation tax and the taxes on the wealthiest in society to ‘unlock their animal spirits’. The aim was to instill some ‘feel good’ spirit to make well-off businesses and people take risks, invest, create jobs, and so grow the economy.

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The people whose animal spirits the ex-government tried to unleash are those most likely to have been directly affected by the financial market turmoil triggered by the mini-budget, and may well feel worse off rather than better off. The main reason for that was the blows to the bond market that took money off the table for the rest of the economy. The price return of the 30-year gilt fell to the lowest since 1980. To be fair, the price was falling before the mini-budget, but the reaction to it materially helped to wipe out all price gains from 2010 onwards, creating the largest annual drawdown since 1980. The Bank of England announcement on 28 September that it would buy as many bonds as necessary until 14 October to restore stability cut some of the losses. The reversal of the mini-budget pledges cut some more. By 21 October the 30-year gilt price had recovered around 86% of the maximum value lost in the post-announcement week. But the damage to the UK’s credibility was done, and 2022 is set to inflict the largest blow to bond prices in four decades. In turn, the establishment of low prices and, reciprocally, high yields along with the pull-out of the Bank as buyer of last resort, could cause several large, defined-benefit pension funds to have unfunded liabilities and require cash injections from their corporate sponsors (taking money out of the economy that could have been used more productively).

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Additionally, the degrowth legacy of the mini-budget is illustrated by the negative equity momentum across UK sectors. Strikingly, and unique to the UK of all large markets, sectors are swiftly moving to the ‘lagging’ quadrant of the chart below or they are already there. They are not moving to or wandering around the ‘improving’ area, they just seem to be taking a short-cut through ‘weakening’ on their way to ‘lagging’. Even traditional ‘growth’ sectors, such as technology, persistently gravitate at strongly negative momentum space in the UK. True, share prices may not be the real economy but they are the barometer which, since the mini-budget, points to a deterioration of conditions that is stronger than would otherwise have been the case.

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Geopolitics have already led to an unprecedented transatlantic divergence between the US and the UK and euro area on expected inflation. The controversial policies of the mini-budget and, more materially, their negative reception by the markets and the loss of credibility that inflation can be tamed, further decoupled the UK from the other two. The UK inflation surge will require higher policy rates, with rates likely to average around 5% over the next two years, according to market expectations. Interest rates and interest rate expectations matter greatly for the UK’s highly leveraged and housing-dependent economy. With more than a million households needing to refinance their mortgages over the next year at potentially eye-watering levels, discretionary spending could be quite significantly limited.

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The mini-budget dashed for growth at all costs. Its binning was welcomed by the market but the tumultuous four weeks of its ‘floating’ gave the UK less growth, more prospective inflation, and additional risks to its housing and banking markets. The Halloween fiscal statement by the incoming, and potentially caretaker, chancellor will detail the new economic plan aimed at navigating the UK economy through the treacherous waters ahead. But politics may change timings and, more importantly, the deliverables, yet again…

The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

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