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UK base rates are expected to hit 4.5%.

  • Wednesday, November 2, 2022

Prime Minister Rishi Sunak There is something profoundly efficient in the UK’s unwritten constitution. It has been able to so quickly and quite ruthlessly removed a failed Prime Minister and started again as if nothing had happened. We can certainly say that we live in interesting times, but times that are serious and concerning to our people and our economy.

Liz Truss wanted to give tax cuts to both business and individuals and use borrowing to off set the lost revenue. The potential for growth through incentive was clear, the outcome however, was that the resulting interest rate rises negated any benefits business may have received.

Liz Trust bowed to the inevitable, but despite her rapid downfall, she did ask some important questions about the future of the UK economy. Past governments of all colours have with the support of the Bank of England, (BoE) borrowed huge sums to support public spending assuming growth was constant, but it is not and we need to find some.

With national debt standing at £2.45tn, declining productivity and a growing trade deficit, Britain’s growth outlook is not strong. For many Brexit was seen as an answer to change course but so far, any such opportunity has been largely missed and our trading relations weaker. Our next few governments will have to answer the key question over how we raise productivity, create new jobs and new industries to replace those in decline, achieve greater efficiencies with public money, reduce our trade deficit, move to reliable and sustainable energy and control inflation. These are tough challenges for the next decade at least.

UK inflation is currently 10.1% which is five times higher than the BoE inflation target. The BoE are very aware that acting only to control inflation with higher rates will only deepen and prolong any recession and punish mortgage holders and business. Higher interest rates will also cost the government more to pay the servicing costs of our national debt.

The UK base rate is currently 2.25% and is expected to rise on 3rd November by 0.75% to 3%. Rising interest rates from historically low and near zero levels to somewhere closer to normal rates is starting to show how fragile some areas of the economy are. The BoE Deputy Governor, Ben Broadbent has stated that the BoE is very aware of the impact that high interest rates will have upon the economy. Analysts are predicting that the highest rate of UK base rate interest is now likely to be 4.5% rather than 5.25% as previously thought. This reduction will filter through in lower mortgage costs.

Economists are split over whether 0.75% will be enough to control inflation. Some suggest that a 1% rise now will show that the bank is serious about inflation. Such a rise could mean that future rate rises could then be less. Others suggest that the BoE should rise rates at 0.5% now ahead of the Autumn Statement and then adjust in December when the government’s fiscal plans are known.

New Prime Minister Rishi Sunak, has already restored some economic confidence to the UK. Since Sunak entered No 10, sterling has risen to US$1.16 up from US$1.095, while 10-year gilt yields have fallen from 4.43% to 3.47%. One could easily think that the most turbulent month experienced by bond markets since 2008 and the Premiership of Liz Truss never happened.

Rishi Sunak’s new government is focused on fiscal prudence and a different winter lies ahead for households and businesses. For example, the energy price cap protection is now to be reviewed after six months and not last for 2 years. The current mild weather has reduced gas demand and that near-term energy prices have fallen. This is a welcome outcome as the imports of LNG mainly from the USA shows that the redistribution of global gas to cover the loss of Russian supply to Europe has been a success and achieved sooner than expected. There is in fact an over-supply of LNG as storage capacity in Europe is full and tankers are waiting to be unloaded.

The Sunak government are taking a hugely different approach to fiscal matters and one that he maintained consistently throughout this summer’s Tory leadership campaign.

The Treasury is warning that everyone will have to pay more tax to put the UK’s public finances on a sustainable footing and that spending cuts alone would not be enough to ensure the government meets its targets on spending and debt. The Treasury has not put a figure on what it calls the “fiscal black hole” facing the UK, but has suggested it may be at least £50bn. It has been reported that Chancellor Jeremy Hunt is planning to fill the budgetary shortfall through a combination of 50% tax rises and 50% cuts to public spending as part of the Autumn statement on 17th November.

What is commonly called a “black hole” in the public finances refers to the amount the government would have to raise taxes by, or cut spending, to meet its medium-term financial targets. The projections are dependent on estimates about how much the economy will grow. The size of the shortfall has shrunk slightly since Mr Hunt reversed most of the measures introduced at last month’s mini-budget. At the time, the Institute for Fiscal Studies estimated it could be as much as £62bn.

The Office of Budget Responsibility (OBR) will publish its forecasts on 23rd November, just after the Autumn statement. We can expect Jeremy Hunt’s budget plans to be fiscally tight over the next five years and that the UK fiscal position will have recently deteriorated. Gilt yields have risen from the summer, forcing the government to pay more for our debt. The OBR’s overall forecast will look worse than their last report but by how much will be key.

A big part of the deterioration in UK standing has been due to global forces. We should not ignore however, that there has been a relative underperformance of UK assets since the June 2016 Brexit Referendum and that the decision to leave the EU will remain a weakness until trade deals and relations with the EU improve. Britain is less resilient to shocks and self-inflicted shocks are ones we should avoid.

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Chris Davies

Chris Davies

Chartered Financial Adviser

Chris is a Chartered Independent Financial Adviser and leads the investment team.

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