By Elena Siniscalco
Britain could be at the brink of a massive turnaround, but you wouldn’t know it if you were to pick up most newspapers. As all corners decry a brewing crisis, there are also generational opportunities we’ve missed in the eye of the furore.
The bulk of Liz Truss’ package is almost undebatable – capping energy prices to support households and businesses through this energy crisis and bring down inflation.
But the most forward-thinking and bold part of the plan is around tax cuts and deregulation, which will finally allow the UK to separate itself from the European approach which strangles growth. For this to succeed, Truss will need the support of her MPs.
In May, Mike Bloomberg penned the op-ed “Why I’m bullish on Britain” calling the UK a “powerhouse and the great financial center of Europe” and citing a number of competitive advantages it holds, including “adaptability and openness to other cultures and ideas” and “the combination of its language and location,” as well as top-ranked universities.
In this context, creating a more friendly environment for businesses while providing further stimulus for households going into a recession is imminently sensible, counter-cyclical planning. What is not so sensible is the hysteria relating to how markets reacted to this not-so-mini budget. There are a few missing points.
First, there is no immediate risk of a funding crisis in the UK. The brief panic in long gilts was effectively a shock to the swaps market, which underlie liability-driven investments for pension funds. The Bank of England, however, has been quick at sending the right signals to restore calm and bring the spiral to an end.
Given higher long yields, however, pension funds will jump on the opportunity to derisk their portfolio by matching assets more closely with their liabilities. In a nutshell, over the coming year pension funds will be forced to sell riskier investments, such as equities, and – wait for it – buy long-dated gilts.
Only a couple years ago, the worry was around how to satisfy the pension sector’s seemingly insatiable appetite for long-dated gilts. How easily we flipped, suggesting some sort of funding risk for the UK. This is nonsensical.
Sterling has not been an outlier, and its weakening against the US dollar has been more a function of dollar strength than pound weakness. This is evident from the fact that over the past year sterling has fallen against the dollar roughly in lockstep with the euro and the yen.
Will Threadneedle Street need to raise rates over the coming year? Of course. But the current forecasts for UK rates are based on the Bank having to keep up with an expected aggressive pace by the Fed – a view which is already starting to moderate from demand-side weakness being seen in the US economy. To the extent the Fed “pivots” as is being bandied about by market strategists, the need for rates to rise in the UK will be less pronounced and a further recovery in sterling will be more likely.
Finally, deregulation on the scale being discussed will be both disinflationary and very positive for growth. The promise of Brexit was to break away from senseless regulations which hold back growth. If the Chancellor lives up to his word, we should expect to see a period of economic prosperity after we climb the initial hurdles of the energy crisis. And yet the UK markets today trade at forward multiples which are nearly 50 per cent lower than the US and 25 per cent lower than Europe. This is not going unnoticed from investors and private equity firms.
Whether the UK will wind up “Singapore on the Thames” or “Florida without the sunshine,” the future is bright.
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