economic #aGENda 21.10

Our regular roundup of financial news from the last two weeks that's driving the economy

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Sterling and bond markets rally on Truss resignation

Financial markets reacted positively to the announcement that Liz Truss was stepping down after only six weeks in the job, as the pound rallied on Thursday.

Before her resignation speech, sterling shot up to $1.13 as markets anticipated that Ms Truss would step down, before shedding gains slightly to stand 0.45% higher at $1.127 when markets closed.

Yields on UK government bonds ― gilts ― have also eased slightly in response to the prime minister’s decision. UK 30-year gilt yields, which fall as bond prices improve, fell back by 0.44% to 3.86% on Thursday. By the end of the day, yields had edged back up slightly to 3.96%.

Commentators said the pound’s knee-jerk verdict was damning, signalling that Ms Truss's move had been welcomed across the City. They do, though, caution that sterling will likely remain volatile as traders digested what this meant for the UK government.

It comes after the pound has suffered a tumultuous two months sparked by the market turmoil seen in the wake of former chancellor Kwasi Kwarteng’s mini-budget – at one stage sterling slumped to its lowest ever level against the US dollar.

A sell-off in gilts sparked by the market chaos also threatened to trigger a mini financial crisis in the UK at one stage, leaving some pension funds at risk of collapse and forcing the Bank of England to step in with emergency action late last month.

The FTSE 100 Index stood 0.1% lower at 6,919.6 as the pound’s rally weighed on blue chips, in particular major UK exporters. But by the end of the day it had jumped back into the green and was up 0.27% at 6,943.9.

There is still plenty of caution towards the UK as an investment destination given the ongoing political uncertainty, the growing risk of recession and Britain’s persistent inflation problem with price levels hovering at 40-year highs.

Focus among investors now shifts to the leadership election, the chancellor’s medium-term fiscal plan on 31st October and the Bank of England’s rate decision in early November.

Which way to go with your mortgage

Mortgage rates have reached their peak and could start to come down over the next few weeks following the UK government’s U-turn on much of its September “mini” Budget, brokers said on Tuesday.

Rates on many fixed deals have risen to their highest levels since the 2008 financial crisis, after UK government bonds sold off in the wake of former chancellor Kwasi Kwarteng’s £45bn package of unfunded tax cuts.

The sharp jump in government bond yields forced lenders to withdraw home loans for new customers, as they had become difficult to price, leaving many prospective homeowners scrambling for a limited number of mortgages.

But brokers on Tuesday said rates on fixed deals were “at a peak” and that lenders would start reducing them in the coming weeks, after a rebound in the gilt market sparked by new chancellor Jeremy Hunt’s reversal of many of the tax cuts.

Commentators believe that Hunt’s announcement of a medium-term debt-cutting plan on October 31 would be important. Provided the chancellor maintains this tone most commentators can see the potential for yields to fall further.

Furthermore, lenders could make more substantial rate cuts after the Bank of England’s Monetary Policy Committee meets to vote on an interest rate rise in early November. The consensus seems to be of cautious optimism that the next few weeks will be the peak for fixed rates, though they will likely remain at this level until November.

Of note, although gilt yields fell on Monday and Tuesday, some lenders had increased their rates, partly to stem the large number of mortgage applications. NatWest on Tuesday said it was increasing rates on a range of home loans because of “recent application volumes”.

According to data provider Moneyfacts, the average two-year and five-year fixed rates rose on Tuesday to the highest level since the 2008 financial crisis. Two-year rates reached 6.53%, while five-year rates hit 6.36%.

Given the unprecedented political and economic uncertainty It might be a few weeks or a few months before any a fall comes through, believe most commentators, who have warned not to expect a dramatic decline in rates, or a return to anywhere near where they were.

Inflation hits 40-year high

Britain’s inflation rate rose to a 40-year high of 10.1% in September, as soaring food costs more than offset price declines at petrol pumps. The jump in inflation as measured by the consumer price index exceeded economists’ expectations, rising from 9.9% in August.

It was driven by the highest food price increases in decades. At more than five times the Bank of England’s 2% target, the double-digit rate will also add to pressure on the central bank for a large interest rate rise on November 3.

The September inflation figures are also particularly important because they are normally used for increasing benefits and pensions the following April.

After the figures were released on Wednesday, Liz Truss confirmed in the House of Commons that state pensions would rise in line with inflation but made no similar commitment to non-pensioner benefits.

With food prices rising at a multi-decade high of 14.6%, economists said poorer families would be hit hardest. Experts believe the rise in essentials such as food and drink - where prices are now rising at over 14% - underlines the need for greater support for the most vulnerable households this winter over and above the energy price cap.

The details of the inflation figures showed there was an increase in the core index as well as higher food prices. The Institute for Fiscal Studies estimated that, with food and energy prices rising fastest, inflation for the lowest-income tenth of the population was 12% compared with 9% for the richest tenth.

The Office for National Statistics, which released the figures, said the overall consumer price index rose 0.5% in September compared with August, a larger increase over the month than in 2021 when the index rose only 0.3%.

The BoE will need to weigh the additional price pressures against the government’s U-turns on unfunded tax cuts and less generous relief on household energy costs, which will reduce medium-term pressures on prices.

Equity release to the rescue?

The cost-of-living crisis has quickly become a cliché — but for good reason. It is likely that many people will struggle to uphold their standard of living for the next couple of years at least.

Perhaps it is no coincidence that, earlier this year, Canada Life published data that showed 20% of equity release clients had borrowed in the first half of 2022 to support day-to-day living costs — up from just over 18% in 2019 and after having seen dramatic dips in the intervening years.

With Nationwide showing that, even with growth slowing, house prices still rose 9.5% in September — representing tens of thousands of pounds for many homeowners — Mortgage Strategy went on a mission to see if current events had spiked interest in equity release and, if so, what brokers — and their clients —should be mindful of.

While for some people equity release might be an appropriate way to deal with cashflow pressure arising from the cost-of-living crisis, it is a long-term product and needs to be looked at with the future as well as the present in mind.

One major consideration to think about might include it being more sensible to downsize, or if there are alternative employment options, such as returning to work if retired.

Commentators have expressed that while they have noticed more interest in equity release, this isn’t as a result of the cost-of-living crisis, but for mortgage repayments, home improvements and to fix in current rates to hedge against further increases.

The vast majority of lenders will only lend money for a specific reason, such as home improvements, debt consolidation or the purchase of another home. The increasing cost of living won’t qualify as a valid reason as this would deem you a client in distress.

Hunt plans raid on bank profits to fill fiscal black hole

British banks are bracing for a potential tax hit to their profits as the government scrambles to plug an estimated 40-billion-pound hole in its finances.

A source familiar with the British government's plans said new finance minister Jeremy Hunt was reviewing the current surcharge on bank profits and would confirm the level when he delivers his medium-term fiscal plan on Oct. 31.

Governments across Europe have been weighing whether to slap new taxes on banks to help pay for state support packages for citizens struggling with soaring food and fuel prices, with both Spain and Hungary proposing one-off levies.

Britain already imposes a levy on bank balance sheets and an 8% surcharge on profits above the 19% rate of corporation tax, although this surcharge was set to drop to 3% next year.

Hunt has not yet decided whether to scrap the proposed cut to the bank surcharge, the Financial Times reported on Tuesday, fuelling investor concerns about the potential tax burden on lenders. "There is a competition angle here which is that as with all tax if you push it too far, you could lose banking activity to other markets and your tax base goes down," said Richard Milnes, bank tax partner at EY.

Shares in British lenders fell as much as 6% in early trading on Wednesday following the report. Shares in Lloyds (LLOY.L) and NatWest (NWG.L) fell as much as 4% and 5% respectively, while challenger Virgin Money slid 6%. The stocks later pared some of their losses but were still underperforming the wider FTSE index, which was flat on the day.

IR35 questions remain

Since Chancellor MKIII’s decision on Monday, the focus from contractors affected by those private and public sector rules, respectively, has become laser-like on two issues.

First, who the actual victims, the tangible losers, of IR35 reform repeal being cancelled are. And second, what the continuance of the frameworks really means. This week, that continuance was highlighted by both HM Treasury and HMRC in comments responding to IR35 reform repeal being rowed back on.

“With or without the reforms, the underlying rules on off-payroll working are unchanged,” began a Treasury spokesperson. “Therefore, anyone working like an employee should pay similar tax as someone who is directly employed.”

An HMRC spokesperson said: “We will continue to support contractors and engagers to understand what they need to do and help them to get their tax right.”

While HMRC said much the same after Mini-Budget’s vow to repeal IR35 reform, taxpayers at least now have guidance (on IR35 of 2000), whereas guidance on repeal never emerged.

In February 2022, the NAO found “HMRC did not give public bodies sufficient time to prepare” and in May, the PAC found “the reforms were rushed in by HMRC”.

But this week, asked if fresh guidance would be incoming, the HMRC official said: “We delivered an extensive programme of education and support before the reforms took effect.

And we have continued to adapt our approach to improve compliance with the rules and support organisations to get things right.” Organisations appear to be among the losers of Mr Hunt’s decision to cancel the cancellation of IR35 reform.