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My task this week is to write about the impact of the UK Budget on markets. The challenge is that there is – needless to say – a lot going on right now and it can be hard to unpack the impact of the UK budget from US election news and company earnings season which has begun in the US. That said, and for those (like me) with shorter attention spans, I would say borrowing is a bit higher than the market expected, growth is also a bit higher and both of these factors have pushed gilt yields higher. These higher gilt yields come in part from the fact that we are borrowing around £28bn a year more than previously (which needs higher rates to entice investors to lend it to us) and in part from the fact that extra government spending (and the boost it gives to demand) leaves less room for the Bank of England to cut interest rates.
You can see the short term impact in chart below which compares the change in yields for the UK, US and Germany over the last couple of days. This shows how much more the UK government (and potentially UK mortgage borrowers!) will have to pay in interest because of the budget changes we saw this week.
I would also say that, so far, this all looks pretty well behaved, especially when compared to the Truss/Kwarteng budget. Back then sterling collapsed to 1.06 to the dollar (driven by capital flight from the UK) and gilt yields were much more volatile (not helped by forced selling by levered pension fund investors). This time around sterling has been stable and the gilt moves have been – if I am honest – pretty much business as usual. 10 year UK yields are still below the highs we saw in 2023 (which did not prove life-threatening for the UK economy) and here is a chart (via John Authers at Bloomberg) showing the 5-day change in the 10-year gilt yield. That spike you can see is the Truss budget.
But will it all work? The fact that UK growth estimates are being revised up a little is no bad thing. The challenge the government faces is that, ultimately, the way we all get better off is via productivity growth (or doing more with less), and UK public sector productivity growth has been abysmal. One way of thinking about the budget is that it is effectively taking resources from the orange line here and giving it to the blue line:
I don’t want to be too negative as there is, I think, still some room for optimism. First, the UK has had the lowest rate of investment of the G7 countries for 24 of the last 30 years. You have to invest to raise productivity and at least this budget is raising investment in the UK. Second, there is one large country that recently borrowed to boost growth and the results – so far – have been pretty good. The (completely misnamed) US Inflation Reduction Act similarly boosted spending and investment for the US government at the start of the Biden administration. I would say it has broadly worked. For all the talk of US exceptionalism, part of the US growth story is that they are running a larger government deficit than other developed countries and so it is the government that is helping with the growth story. If we can replicate some of this over here and get more people back to work (and off long-term disability benefits) then all this might just be a net benefit for UK plc.
We shall see. These are by definition long-term changes that will take years to wash through the system. In the meantime, markets will inevitably react to what is coming next. US technology earnings started this week and they have underwhelmed investors looking for returns on the huge AI investments these companies are making. If you are a market watcher then I would suggest this, and not the UK, is the reason for yesterday’s sell-off. And next week we have the US election. If Trump is re-elected I would expect yields to rise again under the pressure of tariffs and tax cuts. I guess I will have plenty to write about next week too.
Chris Brown, CIO
cbrown@ipscap.com
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