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What can be done to save ‘Broken Britain’?
Investing in the UK macro space is a tough slog right now. Neil Mehta, IG Portfolio Manager, explains why.
Gilts are scarred by past ‘fiscal events’, while the pound is engulfed in what seems like never-ending stagflationary concerns. ‘Broken Britain’ will need a lot of work and healing for it to become an attractive place to confidently invest. The resentment comes back to two factors – inflation and public finances – both of which have plagued policy makers post-pandemic.
Meanwhile, core inflation has stalled at around 3.5%, which is wholly inconsistent with the Bank of England’s (BoE) target of 2%, with price trends and risks tilted to the upside over the coming months. April typically marks the yearly reset in consumer bills linked to retail prices. This year, the average water bill will go up 26% and energy prices will rise 6%, while train fares and broadband prices will also rise above the current rate of inflation.
Moreover, the National Living wage will rise 6.7%, while some employers will need to pass on the cost of an increase in NIC. These continue to feed into wages, with private sector wages running above 5%, much to the bemusement of some policymakers – with the BoE’s Megan Greene recently citing that ‘wage growth is not slowing as fast as I’d like’.
The truth is that BoE policymakers have mis-read the persistence of inflationary pressures over the cycle, be it through poor forecasting or lack of foresight. The labour market has been very resilient too, not helped by problems with official data, which has arguably contributed to easing policy too early. Most BoE policymakers accept that policy was – and still is – ‘restrictive’ – but whether it was ever sufficiently restrictive is another question.
Inflation and higher borrowing costs have had a profound impact economically and politically. UK gilts are being driven by inflation concerns and also a sense of deteriorating public finances. This is why yields have been edging higher of late and continue to exhibit less of a haven bid than peers such as US Treasuries or German bunds.
The knock-on effect has been to constrain the government looking to boost growth and recover its voter base. Looking ahead, the UK fiscal spring statement sets up another political and economic showdown in the autumn. Public expenditure was cut to maintain the Chancellor’s ‘Iron-clad’ fiscal rules but keeps the market guessing on whether more needs to be done come autumn.
The reality is that if gilt yields edge up another 0.6pp on average over the next several months, the government will be forced into more excruciating decisions as the economic choices dwindle, such as income tax rises. Moreover, too many factors could go against the government between now and the autumn, such as lower growth, lower tax revenue, tariffs on digital tax, fuel duty choices, public sector pay awards, a potential Thames Water bailout, and a downgrade to productivity. That’s not to mention potential tariffs emanating from the US, where Bloomberg estimates will hit GDP by 1.1%. The bottom line is that a swirling budget deficit and political uncertainty will continue to mount pressure on UK assets as investors sit on the sidelines, or even short assets.
Turning fortunes around might require drastic action or some form of ‘reset’. One would have thought this was the case in late 2022 after Truss’s now ill-fated budget and the LDI fallout thereafter, but many of the UK’s core problems remain.
Until inflation is under control, and growth is revived via supply side reforms in areas such as housing, energy and the jobs market, confidence will remain low at a macro level.
It could be that we have yet to see maximum pain in the UK macro story. As the former Prime Minister John Major once said, ‘if it’s not hurting, it’s not working’.
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