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Untimely Stimulus? What the Mini-Budget Means for You.

The Untimely Stimulus


The UK's (not so) mini-budget has been creating waves in both media and, more importantly, the markets. The key spotlights are on the various levels of tax relief, funded by additional borrowing. This is aimed at increasing growth, which ultimately enlarges the tax base. This is quite a gamble though because the success of these measures relies heavily on the tax base actually growing fast enough to serve as an adequate source of revenue to fund these short and medium-term deficits.


The scepticism of the wider investor body and even the reserved International Monetary Fund was clearly evident. Investors sold the pound sterling, the British currency, down to the lowest level versus the US dollar in over 35 years and borrowing costs for the government rose at the fastest rate in nearly 40 years. As an incredibly helpful article by Politico illustrates, the market was unimpressed.


Source: https://www.politico.eu/article/british-pound-crashes-to-all-time-low-in-5-charts/



Rock and a Hard Place


The Bank of England (BOE), in particular, was placed in an impossible position. The BOE calibrates monetary policy and was a significant part of the wider trend of central banks tightening monetary policy to combat growing inflation. With investors’ lack of confidence in the government’s economic philosophy clearly evident in their selloff of government bonds (called gilts), the BOE felt as though it was forced to directly step in and purchase gilts in a buyer-of-last-resort type of manoeuvre. Thus, not only has the recent budget introduced a shot of pro-cyclical stimulus at a time when the monetary policy was tightening to reduce inflation by reducing growth but it has also caused the BOE to introduce an incoherence into the execution of its own monetary policy. On the front end of the rate cycle, the BOE is raising rates and has signalled that it will continue to do so for the foreseeable future. However, on the back end, they are committing to buying as many longer-dated bonds as necessary to ensure that the ripple effects of higher longer-term yields would have, both amongst institutional and governmental borrowers. This policy contradiction is likely to result in neither being truly effective. In that situation, market sentiment will likely dominate and the market does NOT like what it’s seeing.


An Economic Experiment?


One perspective take on the government’s action may be illuminated by the rather curious economic philosophy that is called Modern Monetary Theory (MMT). A high-level oversimplification of MMT suggests that the monetary authority acts in concert with the government to ensure that the financing of fiscal deficits does not grow beyond the ability of governments to manage. This means, in theory, the government need not be wedded to fiscal responsibility since there will be a buyer of infinite capacity that will enable the refinancing of its domestically denominated debt indefinitely. This will lead to debt-t0-GDP ratios that are higher than the historical norm but the government remains solvent. One of the reasons that the UK's currency was valued so highly, relative to other countries, is its current debt to GDP ratio is one of the lowest in the G7, at 95.3%; this compares with 132% in the USA and an eye-watering 263% in Japan. This suggests that all things being equal, the UK should have greater fiscal room to repay a growing debt burden than other countries.


Source: Politico - https://www.politico.eu/article/british-pound-crashes-to-all-time-low-in-5-charts/


The primary risk of this is currency devaluation but this is reduced where demand for the underlying domestic currency is strong for exogenous reasons – importance to the financial system, perceived strength of the underlying economy etc. Early signs are suggesting that this risk may be materialising. The market is engaged in a clear repricing of UK debt and the currency to reflect a higher risk premium for holding GBP exposure. Unless the BOE continues its intervention where markets fail, higher market yields may make even a lower debt-to-GDP ratio unsustainable without increasing taxation, which generally puts a damper on future growth.


The Focus - a Bluestone Perspective

Regulatory Relief

For Bluestone though, one key, understated provision is the augmentation of the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS). The investor cap for these tax-advantaged investment programmes was doubled to £200,000. The mini-budget also widened the scope of companies that would be eligible for these programmes. The combination of income and capital gains tax relief, as well as the additional backstop of further relief in the event of failure, creates a more favourable fundraising environment for qualifying UK-based companies and strengthens the attractiveness of integrating these investments into a diversified portfolio.


Another highlight of the mini-budget that may prove helpful is the reduction in regulatory hurdles. For real estate development, the requirement for environmental impact assessments was dropped, potentially improving both time and cost of obtaining the required planning permissions. However, this may reduce the quality of permissible applications, which passes more of the responsibility to improve the sustainability profile of additions to our built environment on to the developers themselves – and investors who support them.


The onshore wind industry also had some regulatory hurdles to the development of new capacity removed. There have been no new onshore wind farms approved for development since 2015 so this is a welcome development and may create opportunities for innovative renewable energy integrations to bring cleaner energy generation options closer to the communities that they serve.


The Silver Lining


Thus, owing to the deterioration of the operating environment as a result of high inflation, labour and skills shortages, growing interest rates, and higher energy costs, even great companies are finding capital harder to attract. This improves the bargaining power of patient investors, who can justify better valuations in return for supporting them through this difficult time. It is in this environment that investors are also most instrumental in shaping the structure of the market – when revenues fall, access to capital determines which companies survive and thus, what the market will look like when conditions improve. This improvement in investor terms can help those bold investors to take the jump and start prudently putting their money to work where it matters.


Disclaimer

This Blog Post is for informational and educational purposes only and is not and should not be interpreted as investment or financial advice. Any investment decisions should be taken in conjunction with a suitably qualified and regulated investment advisor. Bluestone Investment Partners (UK) Limited, its employees, shareholders, directors and agents directly and completely disclaim any responsibility for any decisions taken by each reader of this Blog Post. Bluestone Investment Partners (UK) Limited does not take any responsibility for the accuracy of any of this information.


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