Investors are alarmed at the scale and speed of the drop in UK markets after Kwasi Kwarteng revealed his growth plans. But if the chancellor himself is unnerved, he is hiding it well.
As he spoke in parliament on Friday morning to outline his plans, studded with bigger than expected tax cuts and more than £60bn in extra debt sales this fiscal year, sterling slumped to its weakest point since 1985 while gilt prices stunned analysts with a spectacular collapse .
Through the course of Friday, the pound poked below $1.09 against the dollar — a drop of more than 3 per cent in just one day! And it also took a 2 per cent hit against the euro, showing that this is not just a matter of a roaring dollar.
We’ve seen nothing like this outside of Covid-19, the financial crisis or the crash after the UK voted to leave the EU. By the end of the day, Deutsche Bank analysts were calling for an emergency rise in interest rates as a “circuit breaker” for the system.
Bond markets were in a spin. A drop in gilts prices pushed the yield on 10-year debt up by some 0.33 percentage points to 3.83 per cent, marking a 0.7 percentage point jump in yields over the course of the week — a massive move by the standards of a market that has historically bumped around by tiny increments.
“It’s fair to say that the gilts market hated today’s mini-Budget,” said Jim Leavis, chief investment officer of public fixed income at M&G Investments. Hate is a big word but it does rather fit. Bluntly, global investors are balking at footing the bill of the UK government plans.
But asked in the Commons by an opposition MP about the bond shock and how he might plan to mitigate it, Kwarteng was strikingly sanguine. “The markets will react as they will,” he said, adding that calling attention to the recent drop in the pound was an effort to “talk down Britain”.
Given a further opportunity later in the day to reassure investors, Kwarteng said he does not comment on market movements. “I think it is a very good day for the UK,” he added.
This has echoes of the famous blunder that Christine Lagarde made in the spring of 2020. At the time, Covid was biting and investors were dumping Italian government bonds. Everyone remembers how wobbles in Italian bonds can upset the whole European debt market, so the new European Central Bank president was asked – what would she do? Her response was that she was “not there to close spreads” between Italian bonds and the rest of the market.
Traders clearly disagreed. A bad situation in bonds immediately got much worse, prompting Lagarde to make a swift apology. This situation, however, is different. The UK government is more steadfast.
This period will be awkward for ministers. Markets are fickle, of course, but the drubbing will be used by opposition politicians as a stick to beat the chancellor and prime minister.
Fund managers seem unwilling to back down. “The UK finds itself in the uneasy position of dealing with eye-watering inflation and declining or recessionary growth whilst their currency is being annihilated,” said Craig Inches, head of rates and cash at Royal London Asset Management. “We have been of the view for some time that gilt yields will rise and the UK will underperform its global peers. Today’s mini-Budget rubber-stamps this view.”
But Kwarteng’s response suggests he knew this pushback from markets would come. In time, he told MPs, investors would see how his plan would fire up the UK economy, and “steer us to a more prosperous future”. Maybe so — it’s a long shot, a massive gamble on growth, but it could work.
For now, though, it seems safe to assume the government will let this run, despite the risk that a drop in the pound will make the nation’s inflation headache worse, and despite the upward pressure on borrowing costs that the collapse in gilts implies for home buyers, the state, and everyone in between. Sometimes, financial markets — the ultimate instant global popularity test — act as a helpful counterbalance to governments’ punchier policies. This is not one of those times.
Sterling is at risk of a “confidence crisis”, said Vasileios Gkionakis, an analyst at Citi. So where next? Many believe the pound could easily end up at $1.05, a record low, or even lower. One hedge fund manager offered on Friday to buy me lunch if the rate hit parity. His salary is in dollars so he’s paying.