UK Budget Sparks Market Concerns: Declining Sterling, Rising Yields, and Stagflation Worries

That's a clearer thumbs down…

Gilts are being hammered, and now sterling, too—it is a sell-the-UK trade in the wake of that deranged Budget. Yesterday's sanguine reaction masked some bigger concerns, and it looks like a clear thumbs down now. Certainly, there is a big risk-off move in the market today, with European and US indices also taking a big hit, but we can see some UK-specific action, particularly in sterling.

Cable has broken down through the 1.29 level to hit its lowest since the middle of August around 1.2850..three attempts to break above 1.30 earlier this morning failed, and then the selling picked up steam around 1 p.m. and has continued south since…EURGBP is also rallying a lot as sterling is offered across the board.

The 10yr gilt yield has also shot up today in what’s clearly a post-Budget reflex – I was surprised yesterday at the lack of movement, but we are seeing increasing concern in financial markets about the path of growth and the path of interest rates. More and more it looks like a stagflation deal.

The government is going to borrow a lot more and spend a lot more, but growth will be worse. It’s hard to see the Budget as anything other than a disaster for economic growth. The Budget was demonstrably nothing more than a smash-and-grab on businesses, farmers, and the rich. It does absolutely zero for growth, and in fact, through higher employment and consumption taxes, we will get lower growth as consumers will have less to spend – as the OBR points out in its report that was published with the Budget.

Moreover, the fiscal measures will imply higher inflation and prevent the Bank of England from cutting rates as quickly as they might. This leads us into a stagflation situation.  

The Resolution Foundation has assessed the outlook for growth and the budget changes and calculated the disposable income of the average household, adjusted for inflation, will rise by 0.5% in the next 5 years. The Institute for Fiscal Studies is similarly unimpressed with the way the Budget will drive real income growth. The IFS’s Paul Johnson was “literally banging [his] head on the table” at some of the tax changes. He notes in particular how much extra spending is front-loaded, delivering a short-term boost but “pencilling in implausibly tight spending plans later on”. To avoid real-term cuts to departmental spending, this suggests more tax hikes will be required later on. The big change to the debt rule was saved to the end, switching to public sector net financial liabilities, but there is only £15.7bn of headroom in the final year of the forecast – creating a strong chance they will need to raise taxes again. Paul Johnson points out: “I’d be surprised if the spending plans after 2025-26 survive contact with reality.”  

The OBR predicts a bit of boost to growth but then big headwinds. It forecasts growth at 1.1% in 2024, 2% in 2025, 1.8% in 2026, 1.5% in 2027, 1.5% in 2028, 1.6% in 2029.  

 And this feeble growth looks even less impressive when you look at the extra borrowing.  

And the Budget will raise the cost of living. The OBR notes: "Budget policies push up CPI inflation by around ½ a percentage point at their peak, meaning it is projected to rise to 2.6 per cent in 2025, and then gradually fall back to target." Low growth, higher inflation, higher interest rates, higher borrowing costs and more debt...hardly the sunlit uplands.