Markets react well to chancellor’s speech but political uncertainty persists
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The speech delivered by the new chancellor Jeremy Hunt this morning seems to have calmed the markets, but experts warned markets are “fickle” and political uncertainty around Liz Truss as the country’s prime minister remains high.
Hunt, who replaced Kwasi Kwarteng as chancellor on Friday, delivered its first fiscal statement today, claiming it reverses “almost all” the proposals announced during Kwarteng’s Mini Budget on 23 September, which proved to be unpopular in the financial market.
Among the new measures, Hunt said the basic rate of income tax was to remain at 20% until economic conditions allow for it to be cut, and the reforms to the off-payroll working rules IR35 and dividend tax rate were longer going ahead.
He also removed the Energy Price Guarantee scheme after next April saying it would be replaced with something more targeted.
Hunt kept the National Insurance (Health and Social Care Levy) and stamp duty cuts, both already well progressed through Parliament.
These are in addition to the reversal of corporate tax cut announced on Friday.
Austerity appears “on the table”
Danni Hewson, AJ Bell financial analyst, said the new chancellor has bought the government “some breathing space” but added: “Markets are fickle and two weeks is a long time in economics as in politics."
“It’s a pretty easy and obvious step to reverse most of those unfunded tax cuts announced in the mini-budget but it’s less straightforward to move the debate along. And that’s where the real risk lies, austerity might not be palatable, but it seems to be on the table."
Hewson said inflation is "still devastatingly high" and interest rates are expected to go up.
Yields are lower but remain high
David Page, head of macro research at AXA Investment Managers, said government stimulus has been reduced to around 4.5% of GDP over five years from over 11% after the Mini-Budget was delivered last month.
He added the moves have helped calm gilt yields in the first day of trading without direct Bank of England support. The lower yields will also be incorporated in the Office for Budget Responsibility’s Economic Assessment with the Budget on 31 October.
But Page warned yields remain higher than they were before the Mini-Budget suggesting lasting higher borrowing costs after the government’s “mistakes”.
He called today’s statement “nothing short of a complete overhaul” of Prime Minister Liz Truss and previous Chancellor Kwarteng’s previous Mini-Budget.
“From a market perspective, today’s announcements have helped calm markets and reduced the risk of a further sell-off in gilts in the first day without BoE purchases. Ten-year gilts had rallied on Friday on hopes of a more substantial adjustment by the Prime Minister, yields falling from 4.2% to 3.9%, only to sell-off after her speech, yields returning to 4.35% close Friday.”
He said yields remain relatively high and this illustrates that while the chancellor can reverse most of the measures of the Mini-Budget, "it is more difficult to reverse the market impact”.
Political uncertainty still high
Page said markets that are affected both by gilt yield volatility and the erosion of the government’s fiscal credibility is “something that is quicker to lose than to gain”.
He said: “With several Conservative MPs joining opposition calls for her resignation, political uncertainty is likely to persist,” Page said.
James Athey, investment director at abrdn, said the prime minister’s position “is so incredibly weak that this counts for nought right now”.
“Conservative Party members might as well have voted for Sunak and saved us all this angst because we are ending up pretty much where the former Chancellor wanted during his campaign for the top job.”
Athey concluded: “The next question likely to be posed by international investors is just how long the PM can now survive.”
Will there be a new prime minister by the end of this year?
