A year after market turmoil, the U.K.'s chancellor is back in the spotlight

By Jamie Chisholm

U.K. finance minister Jeremy Hunt will present his Autumn budget on Wednesday. He'll be hoping it goes a lot better than his predecessor's a little over a year ago.

In September 2022, Kwasi Kwarteng, the new Chancellor of the Exchequer -- as the position is known -- delivered a seasonal budget statement at the behest of freshly-installed Prime Minister Liz Truss, that proposed a GBP45 billion package of unfunded tax cuts.

Fair to say, this perceived fiscal incontinence was not well-received by the market.

Why, investors asked, was the U.K. government proposing a stimulative 'mini budget' at a time when the Bank of England was struggling to combat inflation, then running at more than 10%?

Traders were spooked by the prospect of the central bank having to raise interest rates further in response, which, combined with a likely increase in government bond issuance to pay for the tax cuts, would push yields sharply higher.

A spiral of bond selling was triggered as pension funds who had made highly-geared bets on fixed income assets were forced to dump their holdings. The Bank of England had to step in to back-stop the U.K. government bond market and save the pension sector.

So, what will Hunt do this time? Well, the first thing to note is he delivered a previous budget in March, which didn't rattle traders, and importantly this week he will address the House of Commons within a different market environment than a year ago.

U.K. inflation is now 4.6%, still well above the Bank of England's 2% target but tracking declines seen in other developed economies. Consequently, with the fear of price pressures not what it was last September, traders are less worried that a growth-focused budget may cause the central bank to take borrowing costs sharply higher in response.

In addition, though current benchmark government bond yields around 4.11% are near the level to which they initially rose immediately after the Kwarteng budget, the reason for their elevation is more benign, with the U.K. economy having unexpectedly managed to avoid a technical recession this year.

Does this mean Chancellor Hunt can revive the Conservative tax-cutting instincts of Truss and Kwarteng, who balked at the sight of U.K taxes at their highest as a proportion of GDP in 70 years?

Well, not really. He is expected to be conservative in his Conservatism. The weak economic growth means government revenues are a bit better than expected but not by much, while the expenditures of some cost-of-living subsidies still linger.

Data released Tuesday showed the government spending GBP5.5 billion more than forecast for the month of October, and these latest set of public sector finances demonstrate what a tricky position the chancellor is in, according to Danni Hewson, AJ Bell head of financial analysis.

"The government is still spending more than it's got coming in, having to balance higher interest payments with increased costs on things like benefits and wages," said Hewson.

And even though his own rules will require him to tread carefully, she said it appears "incredibly unlikely that the chancellor won't bow to political pressure to hand out some kind of crowd-pleasing, headline-grabbing treat."

A Treasury official on Tuesday confirmed the largesse will be a trimming of personal taxes. A 1p cut to the basic rate of income tax, for example, would benefit 36 million people who would gain an average of about GBP200 a year, according to Torsten Bell, director of the Resolution Foundation think-tank.

Aside from that, the government ledger dictates that this Autumn Budget is likely to be a cautious affair, with perhaps some trimming of inheritance taxes and possibly rebates on property-buying taxes to encourage greener homes.

"The public finances outlook has turned murkier...and while we expect the Chancellor to meet his primary (getting debt to GDP down) and secondary (getting borrowing below 3% of GDP) fiscal rules (by the end of the forecast horizon), the margin for error remains historically slim," wrote Sanjay Raja, senior economist at Deutsche Bank in a note.

George Buckley, economist at Nomura, said: "Mr Hunt will undoubtedly want to keep some of his powder dry ahead of next spring's Budget -- which may be a more opportune time to win over voters ahead of a possible autumn 2024 election."

For sure the cut in income taxes is one way to ameliorate hard pressed voters. But the Conservatives remain some 20 percentage points behind the Labour opposition. The British electorate's faith in the Tories' fiscal prudence remains badly damaged by last Autumns' calamitous budget.

-Jamie Chisholm

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11-22-23 0320ET

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