How does the mini budget U-turn alter the course for markets?

With most of the measures contained in September’s so-called mini budget reversed, how will markets and the economic outlook be affected?

18 Oct 2022 . 3 min read

In a bid to reassert the country’s fiscal discipline, return the public purse to good health and – nearer term – steady markets, the plan which just weeks ago contained some £45 billion in tax cuts retains just three of eight policy proposals outlined by former Chancellor Kwasi Kwarteng. What are the key takeaways for markets and businesses?

What was announced?

On Monday 17 October, the new UK Chancellor, Jeremy Hunt, announced a swift reversal of three-quarters of the measures contained within September’s mini budget. All of the tax cuts contained within the mini budget revealed 23 September, aside from National Insurance and Stamp Duty, have been abandoned.

Perhaps more radically, the energy price guarantee beyond April 2023 will be reviewed with a view to replacing the universal price freeze with more targeted support.

Finally, the Chancellor indicated that further cuts to public spending and / or tax increases might be required.

What does all this mean for the UK’s finances?

Precise details on the savings from the policy changes are scarce.

In televised remarks, the Chancellor said reversing the tax measures, including the previously announced freeze on corporation tax and keeping the top rate of income tax, would raise around £32 billion per year. And we would expect changes to the energy support scheme to run in the low tens of billions of pounds.

A clearer picture should emerge when the mini budget is tabled alongside revised economic projections from the Office for Budget Responsibility on 31 October.

What can markets expect from here?

Although the Chancellor’s announcements this week (and the Bank of England’s interventions this past fortnight) don’t materially alter the gilt supply outlook, they are likely to calm markets and reduce some of the extreme volatility seen in recent weeks.

Pressures on Sterling longer term could ease

Sterling regained some ground against the US dollar and the euro in the initial aftermath of the announcement, with investors buoyed by the prospect of greater UK fiscal sustainability. We’re a bit more cautious in the near term. Despite a seismic shift in government economic policy, much of the of the downward pressure on the pound today remains; the largest part of the stimulus is the price cap, not tax cuts, after all.

That said, not everything leans towards Sterling weakness. Yes, pressure from high energy prices is acute. But prices have come down of late, and if that persists borrowing will be noticeably lower than assumed from this very costly policy. Throw in a few delayed tax cuts and windfall tax increases, lower market yields and less aggressive Bank of England monetary tightening and suddenly, the future doesn't look as challenging for the pound. So in our view, the outlook for Sterling looks more balanced than it did a few weeks ago.

Gilt yields will peak slightly lower on lower supply, with 10-year notes hitting 4.3% by year-end (instead of 4.5%)

The fiscal measures announced this week coupled with a deteriorating economic outlook make the outlook for gilt issuance beyond this year more uncertain. We see public sector funding requirements more or less unaltered this year (at around £182 billion) – as most of the policy reversals take place from next year.

But the cost of the energy support package – both in terms of design beyond April 2023, and changes in wholesale energy prices – could sway borrowing levels dramatically. The mid-point of our reasonable range of estimates implies the central government’s net cash requirement might total £175 billion next year, implying gross government financing needs of roughly £300 billion, which is substantial.

So, despite the U-turn, question marks remain over the scale of funding required next year. Ultimately, the supply of gilts still looks set to increase significantly compared with pre-covid levels (which is what triggered this initial bout of market turmoil). And in a high inflation, low growth world, this additional supply is going to struggle to find a home. This will mean higher borrowing costs for government – and corporate bond issuers.

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