To say that September was an eventful month would be an understatement.
The country came together in mourning Her Majesty the Queen, who died at the age of 96.
Just days before, as was widely predicted, Liz Truss was appointed Prime Minister. One of her first actions was to limit the energy price cap to £2,500, much to the relief of many households. However, a highly controversial mini-budget followed, of which the implications proved to be not so mini.
We are still in the midst of economic uncertainty, with strong indicators that we are heading for recession.
A New Prime Minister
Liz Truss and her new government have been extremely busy during their first few weeks.
After weeks of concern and speculation about the energy price cap, it was quickly announced that this would increase to £2,500, rather than the £3,549 initially announced. This would not, as Liz Truss herself claimed, cap the level of bills for all households. It would simply limit the unit price of energy to keep the bills of a ‘typical’ household at around this level.
The mini budget quickly followed, including a series of measures to cut tax and reduce regulation. For example:
- Removing the 45% rate of tax (although the government has since backtracked on this point).
- Cutting the basic rate of tax to 19%.
- Scrapping the planned increase of 1.25% to dividends and National Insurance Contributions.
- Promising to keep Corporation Tax at 19% rather than increasing it to 25% as planned.
- Reducing stamp duty for house buyers by increasing the threshold at which it becomes payable.
- Removing the cap on bankers’ bonuses.
- Confirming that household support for energy bills would not be paid for by a windfall tax on energy companies, but by borrowing.
- Cutting planning restrictions, including environmental requirements, allowing greater freedom to build new homes.
- Increasing the responsibilities of Universal Credit claimants to find work or increase their hours.
The budget has been poorly received by the public, the media, and many politicians on both sides. Not only does it favour some of the wealthiest in society, it also puts pressure on public finances. The goal is to borrow now to fund future growth, but with the economy currently stagnating, the best case scenario is that this will take several years. While tax cuts might make it more attractive to invest in the UK, investors and businesses are understandably nervous about staking their future on an economic gamble.
How Have the Markets Reacted?
The FTSE 100 dipped following the announcements, although had already been falling since mid-September. Mid-cap companies (as listed on the FTSE 250) were hit harder, losing over 6% on the back of the measures.
Some of the worst performers this month include Hilton Food Group (which supplies meat to the main supermarkets) and Royal Mail, which is once again in the midst of strike action. By far the top performer this month is Avon Protection – this has nothing to do with cosmetics or insurance, but instead supplies safety equipment to the military, and is thriving following a large order from the US Army.
UK Gilts faced heavy losses, having already been in turmoil this year due to interest rate and inflationary concerns. This was made worse following the new measures, which would push the country further into debt. Gilts are traditionally a safe option for investors, so this indicates the current lack of confidence in the UK economy.
The property market received a temporary boost from the reduction in stamp duty. However, as the cost of living rises and mortgages have become considerably more expensive it is likely we will likely see significantly falling house prices next year.
This lack of confidence has also translated into the currency valuation. Sterling has dipped by around 9% in the last quarter, the worst decline since the 2008 financial crisis. At one point, it reached its lowest level since 1971, although it picked up slightly in the days that followed. In contrast, the dollar has strengthened.
A weak pound makes it more expensive to buy from abroad. As many of our everyday purchases rely on imports, this could make inflation and therefore the cost of living rise even more.
In terms of share prices, a weak pound will have implications for companies depending on how they make their money. A company importing goods from abroad to sell in the UK will probably struggle. However UK exports might become more attractive to overseas consumers as they will get more for their money. Many UK-listed companies make most of their profits on a global scale, so won’t feel as much impact.
Similarly, if you hold shares in overseas companies, you might see a boost in value. This is simply down to the local currency being worth more when converted back to Sterling.
Investors might not see an immediate downturn from a weak pound, but the implications are not good for the UK economy.
The Bank of England’s Response
The Bank of England promised ‘robust’ action in response to the mini budget. It plans to buy large quantities of long-dated gilts over a short period. This is expected to reduce the cost of government borrowing and hopefully calm the market.
One of the main consequences of volatility in the gilt market is that pension funds are at risk. Not only do many occupational pension funds invest significant amounts in gilts, but many use gilt yields as the basis for their calculations around members’ benefits. An unpredictable gilt market can threaten the retirement security of millions of people.
The Bank of England’s role is to maintain financial stability, but this is usually due to external factors, rather than a direct response to our own government’s policy.
The Global Outlook
The news has seemed UK-centric this month as we have faced a number of shocks in quick succession.
While the UK is one of the more volatile markets at the moment, the effects of the cost of living crisis are rippling across the world.
The North American sector has dipped around 4.6% this month, although is looking relatively stable on a one-year basis. While the market is down, employment data is positive and the expected aggressive increase to interest rates is already priced in. The US is dominated by global tech companies such as Microsoft and Apple, which means that it is fairly resilient even in volatile markets.
Europe and the Asia Pacific region have both dipped by around 6.5% this month as inflation and rising interest rates continue to cause concern. China, as the world’s manufacturing hub, continues to face headwinds including the aftermath of the pandemic (and their resulting restrictions) and a shortage of young skilled workers.
The value of investments can fall as well as rise and is not guaranteed. Past performance is not a guide to future performance.
The content in this article was correct on 05/10/2022.
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