A Letter from London - Economic Update: November

The Rt Honourable Mark Field
November 28, 2022
Company News


It seems scarcely believable that a mere fifty-five days separated this month’s Autumn Statement from its predecessor, the now notorious Truss/Kwarteng mini-budget.

The impulsive and reckless optimism that typified that initial financial package (garlanded with praise on the day after it was delivered by Conservative supporting newspapers and think-tanks as well as plenty of Party activists) contrasts with the sober discipline and restraint of the new Administration.

From a determination to go for growth at all costs in order to stave off the prospect of recession, UK economic policy has been so transformed within a few weeks that the current PM and chancellor's risk averse approach to the public finances means they seem prepared to live with the consequences even if recession results.

Much of the detail of frozen tax thresholds (a highly effective income raiser in an era of rising inflation); reduced in-work entitlements; corporation and capital gains tax tightening and the like had been leaked in advance in an attempt to manage - and perhaps manipulate - expectations, but also in recognition that official forecasting during these turbulent times has been erratic at best.

The sense that 'the grown-ups are back in charge' after the chaos of the latter months of the Boris Johnson premiership and the Truss interlude has certainly helped calm the markets. However, the economic outlook has also darkened markedly.

Indeed, the tax rises and spending cuts set out by Sunak and Hunt in recent days reflect that UK policymaking has become almost entirely dependent upon keeping the international markets on-side. Erring on the side of caution and respecting orthodoxy have once again become the name of the game. This should come as no surprise - after all, the national debt has more than tripled since the financial crisis of 2008, a situation that only appeared sustainable for so long as the cost of borrowing (interest rates) were kept to near zero levels.

At the turn of this year, inflationary pressures finally persuaded G20 central banks to start the long-march back to interest rate normality. As a consequence, highly indebted nations, companies and households have been required for the first time in over a decade to become sensitive to market conditions.

Orthodox economic theory, of course, points to a loosening of monetary and fiscal levers when recession is imminent. There is little sign of the UK economy overheating (the usual cause for aggressive interest rate raising); on the contrary cost of living pressures have been heightened by global supply chain bottlenecks in the Covid aftermath and violent energy price volatility following the invasion of Ukraine.

In all fairness to the Treasury, the Autumn Statement set out a series of departmental spending curbs most of which will not come into play until 2025. Whilst this enables a change of course if inflation were to be slain within that time frame, it also gives rise to suspicion that these plans are 'too clever by half' as the financial reckoning can is kicked yet further down the road.

Arguably they have been crafted in this way in order to put pressure on Opposition Parties either to endorse these arrangements or announce their own fully costed (and scrutinised) economic strategy before the next election. However, apparently clever political tactics risk further undermining international investor confidence in the UK, to say nothing of this package's impact on the household budgets of the working population who will face the cost of underwriting sharply increased borrowing (predicted to rise to £177bn or 7.1% of GDP over the next year) before the real curbs on public spending kick in.

When I speak with seasoned City observers their abiding concern is that the drama that played out over pension fund viability after the 23 September statement may turn out to be something of a canary in the mine. Deeper economic upheaval may lie ahead. After all, there remains a huge mountain of debt in the global financial system; we stand in the midst of a cycle of upward movements in interest rates on an accelerated scale that has caused widespread unease and alarm; meanwhile the opaqueness of debt instruments still underpinning the global financial eco-system has worrying parallels with the apparently benign conditions that apparently applied on the eve of the last financial crisis. Despite the risks to business confidence, maintaining market stability after recent events may have left the government with little choice but to introduce a new era of austerity.

This will be highly problematic. Even the backloaded public spending cuts announced by the chancellor this week will impose public sector pay awards set at levels well below inflation, reducing the real value of the take-home pay of nurses, teachers and the police, for example. Further industrial unrest is now on the cards.

The slashing of public infrastructure budgets is always low-hanging fruit for any departmental cuts. Whilst the government has reaffirmed its commitment to high profile and highly expensive projects such as Sizewell B (nuclear power) and HS2 (rail), a closer inspection of the Office of Budget Responsibility's workings show a significant reduction in medium term public investment which risks adversely impacting future productivity and growth. The importance attached after September's upheaval to maintaining credibility in the financial markets by over-compensating with clear pathways to a (more) balanced budget and rapidly tamed inflation makes a sharp, deep recession almost inevitable.

What of the political consequences of all this?

Recent UK electoral history points to the two contrasting outcomes that applied after a decade or so of Conservative government in 1992 and then five years later when the Party was finally ousted after eighteen years in office.

Rishi Sunak will be hoping to emulate the playbook of that earlier contest when, in the midst of a deep recession, the Conservatives were unexpectedly re-elected under a fresh leader, who persuaded the voters that a change of government was too risky.

One less observed consequence of the recent extreme market turbulence is that the overriding need to maintain financial stability will equally enforce economic orthodoxy on the Opposition Labour Party. On the one hand this presents its leadership with internal party management challenges, but on the other it provides reassurance against political accusations that the policy platform of an incoming government would destroy market credibility. Perhaps the abiding lesson of 2022 and beyond is that the entire UK political class is answerable to the whim of the markets these days.

The difficulty faced by the current administration is that the upheaval of the past nine months in particular may well have irreparably damaged the Conservative brand in the eyes of the electorate with the next general election now only two years away at most. The more PM Sunak acknowledges that 'mistakes were made' by the ill-fated Truss government, his own central role in the previous administration comes under greater scrutiny. His innovative furlough scheme introduced at impressive pace in 2020 when he was chancellor preserved countless jobs and business, but its costs have proved ruinous and a reckoning over fraudulent and unwarranted claims on the public purse may yet cause him political grief.

The lull in hostilities within the Conservative Party may also prove shortlived. Some MPs and many party members regard the events of recent months as little short of a coup against the hardline Brexit they craved. Many are as privately unreconciled as ever to a Sunak premiership and the re-emergence in government of some of his key supporters. Dissent in the ranks is already simmering at the more immediate prospect of the disproportionate impact on middle-earners of the substantial tax hikes that have stabilised the markets and underpin the Autumn Statement. Meanwhile the persistent failure to deal with illegal, small boat migration in the Channel and the deteriorating state of many public services will further test party unity.

The personality feuds that continue to beset the parliamentary party also risk being played out very publicly. The settling of old scores bubbling beneath the surface as one faction finds itself back at the ministerial helm and is undermined by the other clique now restless on the backbenches shows few signs of abating. In the meantime despite the change in leadership, the Party's opinion poll ratings have remained dire whilst each month brings the day of electoral reckoning closer...

The views, thoughts and opinions expressed within this article are those of the authors and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security or to make a bank deposit.

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