As Britain’s Mini-Budget U-Turns…

Editors’ Note: MarketMinder is politically agnostic. We prefer no politician nor any party and assess developments for their potential economic and market impact only.

UK politics keep moving at warp speed, continuing bond markets’ wild ride. When last we left you Friday evening, Prime Minister Liz Truss had replaced Chancellor of the Exchequer Kwasi Kwarteng with Jeremy Hunt and U-turned on her prior plans to cancel the corporate tax hike scheduled for April. At the time, Hunt was due to unveil the government’s new economic plans on Halloween, and Truss had seemingly managed to shore up her position a wee bit. But after a weekend of leaks and rumors about an intraparty coup, Hunt unveiled the new economic plans two weeks early and U-turned on the vast majority of Truss and Kwarteng’s prior proposals, leaving most Westminster insiders speculating that her days are numbered. The UK’s 10-year Gilt yield fell over 41 basis points to 3.97% in response, mid-to-longer-term European 10-year yields fell modestly in sympathy and medium-term US Treasury yields inched lower, while the S&P 500 jumped 2.6% on the day.^[i] We see all of this as a sentiment reaction—much ado about a lot of political wrangling and very little actual change. Moving on from this saga, however it resolves, probably reduces uncertainty and gives markets one less thing to stew over.

Hunt’s new package keeps a handful of Truss and Kwarteng’s earlier proposals. The reversal of April’s 1.25 percentage point (ppt) increase to the tax that funds Britain’s National Health Service, which has already begun its journey through Parliament, will go forward. So will the low-tax “investment zones” and the increased threshold for “stamp duty” on home purchase, which will rise from £125,000 to £250,000. The cap on bankers’ bonuses will still be scrapped, and households will still get relief from higher energy prices … with a catch. Where the original plan ran through the next two winters, Hunt’s version will end in April, and he hinted that it would be means-tested.

The rest of the “mini-budget,” however, is gone. We already knew the top income tax rate would stay at 45% for incomes over £150,000, reversing the pledge to make the 40% rate on incomes over £100,000 the top rate. And we knew the corporate tax rate would rise from 19% to 25% next April after all. But today Hunt announced that the “basic” income tax rate will stay at 20%, reversing the mini-budget’s pledged cut to 19%. He also said alcohol duty will rise with inflation after all, scrapped a VAT reform scheme that sought to boost tourism spending, canceled the proposed reversal of April’s 1.25 ppt dividend tax hike and backed off plans to simplify tax for self-employed people.

In our view, pundits’ reaction says more about bias than the actual merits of these changes. As we wrote at the time, we thought the mini-budget mostly lived up to its nickname. As a series of small tax cuts that would have only partly offset the hit households have taken from stealth tax hikes (via tax bands staying frozen through 2026 instead of rising with inflation) and falling real incomes, they wouldn’t have turbocharged economic growth. Nor would they have blown a hole in the UK’s long-term finances, considering the country’s debt burden is overall cheap relative to tax revenues and has a long weighted-average maturity. Moreover, canceling the cuts merely extends a status quo that markets were already used to. So from our standpoint, not much changed. But you wouldn’t know this from most of the coverage, in which some of the same entities who derided the mini-budget as irresponsible unfunded tax cuts are now wailing about Hunt’s vicious “austerity.” (And with no hint of irony that we could detect.) Simple logic holds that both viewpoints can’t be true. But we have long since learned not to have such high expectations.

We view Gilt yields’ reaction as similarly overblown. The mini-budget was highly unlikely to drive up debt and inflation sufficiently to warrant 10-year borrowing costs’ rising by over a full percentage point. The forced selling at pension funds that contributed to it was more of a technical issue than a market verdict on the UK’s public finances. Hence, shredding the mini-budget probably wasn’t necessary for yields to eventually embark on a round-trip to pre-mini-budget levels. It likely just accelerated what would have happened anyway, consistent with how wild sentiment has been lately.

As for the political future, who knows? We have seen all manner of rumors today, with calls for both a Conservative Party leadership change and a snap election. We have seen talk of Truss’s imminent ouster, and prediction markets anticipate a swift coronation of Sunak. Some say Truss could go this week, others later this year, and still others offer a general “before the next election,” which is due in 2024. Some are lobbying for the return of ousted Prime Minister Boris Johnson. Some wish to usher in a new leader without party members voting, which still others warn will split the party permanently, paving the way for a more populist upstart party to emerge as a viable political force. We won’t hazard a guess as to how any of this goes. Rather, it all shows political uncertainty is off the charts right now, which probably keeps sentiment toward the UK on edge for the time being.

Eventually, this uncertainty will fade. However the situation resolves, and whoever ends up in charge, markets will get clarity and investors will move on from this drama, which should be positive for markets. Even if the results aren’t what you might hope for from a political standpoint, markets like it best when businesses and investors have clarity. It eases legislative risk aversion and enables risk-taking and investment. Whatever party or leader that comes under, simply having it should give markets some relief.