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William Vaughan and Katie Klingensmith
There has been quite a stir in the UK Over the past few weeks, the world has been glued to the historic funeral of Queen Elizabeth II. hijacked headlines and sparked the sale of British assets.
Gold coin yields are skyrocketing, the pound is plummeting, and even hit record lows against the US dollar (USD). What factors have caused the large volatility in the UK currency and bond yields (see Figures 1 and 2)?
First of all, one of the main causes is the announcement of government ‘mini’ budgets. This includes some surprises that caught the market off guard. On the one hand, there are tax cuts. Energy subsidies are on the other side.
Markets generally expected energy subsidies, but not the size of tax cuts. The new budget calls for a significant reduction in the top tax rate from 45% to 40%.
This move to benefit the highest earners is essentially trickle-down economics on steroids. On the other side of the scale, lower rates give you a slight haircut from 20% to 19%.
Essentially, these changes will significantly boost the disposable incomes of top earners while the country faces steep inflation, an energy crisis, and a potential recession. This could also be a form of inflation protection. Of course, politics and communication are getting a little out of hand.
Moreover, energy subsidies can create almost unlimited liability to governments. In contrast, some governments in Europe may offer an initial allowance (subsidized cost), the rest depending on the energy market and usage.
The combination of unlimited liability in the UK and tax cuts for top earners is therefore a poor view. The UK is experiencing a cost of living crisis that will have to be financed through increased government spending when interest rates are already high.
After two consecutive 50 basis point (bps) rises in interest rates and the pound close to parity with the US dollar, everyone is waiting for some shock and awe-inspiring intervention from the Bank of England (BoE). .
The BoE stepped in to stabilize the bond market, suspending the sale of government bonds and the purchase of long-term government bonds for a period of time, but the central bank has not scheduled a meeting for some time and is still far behind. increase.
The fact that one of the members of the Monetary Policy Committee called for a rate hike of just 25 basis points last week shows just how far behind. A double deficit and the current simultaneous sale of gold coins and sterling puts the UK in a worrisome position.
Looking ahead, governments are betting big that the trickle-down economy will work, and it will do so in the next few years. The British pound (GBP/USD) just above par (1.0) could make the entire UK portfolio very attractive.
Additionally, the UK economy relies heavily on foreign direct investment (FDI) to finance much of its spending. Again, at some point interest rates and assets will look very attractive to foreign investors.
In the meantime, the government could do a better job of communicating the supply-side reforms that are a key component of these spending programs. Instead, tax cuts for the wealthy grabbed all the headlines.
The situation in the UK has received global attention, but it may remain a local story. The UK has one of the lowest debt-to-gross domestic product (GDP) ratios among the G7 countries The government apparently thought it was well positioned to introduce this kind of budget package.
However, the market reaction that gold prices and currencies are moving in the same direction is a big warning signal for the rest of the world. As other countries face possible regime change over the next few quarters, including Brazil, Italy and even the United States, with midterm elections looming, it will be time to learn from the implications of Britain’s latest fiscal and monetary experiment. would be wise .
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Editor’s Note: The summary bullet points for this article were selected by the Seeking Alpha editors.
