Transcript
Speaker: You're listening to the HSBC Global Research Macro Viewpoint, our weekly review of the key reports from our economists and strategists across the globe.
Speaker: Hello and welcome to a special edition of the podcast.
Speaker: It's been another eventful week here in the UK.
Speaker: As we record, Liz Truss has just announced her resignation as Prime Minister against a backdrop of significant challenges for the UK economy.
Speaker: all of which leaves a lot to be discussed ahead of the budget scheduled for the 31st of October.
Speaker: To do this, I'm joined by Liz Martins, Senior UK Economist, Dominic Bunning, Head of European FX Research, and Danny Russell, Head of UK Rates Strategy.
Speaker: Before we begin the discussion, just a reminder this podcast was recorded on Thursday, the 20th of October, 2022.
Speaker: Our full disclosures and disclaimers can be found in the link attached to this podcast.
Speaker: So Liz, turning to you first, we know now that Liz Trust has gone, we know there's going to be a leadership contest next week.
Speaker: Do we know that there's going to be a budget on the 31st of October?
Speaker: Well, it looks like we are going to still have the budget on the 31st of October.
Speaker: And I think it'll be a priority for the government, given how much of an impact fiscal uncertainty has had in recent weeks.
Speaker: But it does create the unusual situation of a new leader, a new PM coming in and having very little choice in the policies that will be in the budget that follows three days later.
Speaker: One of the perceptions would be that a lot of the tax cuts which resulted in all this concern about funding have been reversed.
Speaker: But in your report, you highlighted, in fact, the shortfall in terms of funding for the government is much worse than that.
Speaker: Yeah, that's exactly right.
Speaker: So the Office for Budget Responsibility estimates a shortfall, if you want to stabilise the debt-to-GDP ratio, of £72 billion.
Speaker: Now, the reversal of policies would plug £32 billion of that gap, but that, of course, still leaves £40 billion in savings that perhaps need to be found.
Speaker: So this is why the new Chancellor, Jeremy Hunt, said there are still some eye-wateringly difficult savings
Speaker: decisions that need to be taken.
Speaker: So we know what's not going to be in the budget, all those policies that have now been cancelled, but we don't yet know what is going to be in the budget in the form of additional tightening measures.
Speaker: Do you have a sense of what sort of measures could be announced?
Speaker: Well, I mean, obviously, tax rises and spending cuts are the way that you close these kind of gaps.
Speaker: On the tax rises side, we've been hearing about possibly a tax on the banks.
Speaker: And on the spending side, you know, it could be anything.
Speaker: It could be welfare spending.
Speaker: There's been a lot of talk about potentially uprating pensions by...
Speaker: earnings instead of inflation that effectively goes against the triple lock and would be very controversial.
Speaker: And by that, I mean the commitment by the government to raise pensions by whichever is higher out of earnings, inflation or two and a half percent.
Speaker: Then you've got departmental spending cuts, but that's difficult with public services already under strain.
Speaker: And then you've got investment spending cuts, which of course might be less noticeable in the near term, but weighs down on the very growth that the government is
Speaker: trying to generate.
Speaker: So there's no palatable options here, really.
Speaker: And there is also this wild card you mentioned, a bit of a technical point regarding reserves that banks have with the Bank of England.
Speaker: Can you explain what that is and why you think it might be misguided?
Speaker: Yeah, so one of the reasons we've got this black hole in the public finances is because spending on servicing UK national debt is going to rise quite sharply because interest rates have gone up.
Speaker: And one of the drivers of that is the Bank of England paying interest on the reserves that banks hold with it as part of the QE programme.
Speaker: Now, if it were to pay interest
Speaker: only on a portion of those reserves, it would save a lot of money and that would help the UK public finances more broadly.
Speaker: Now, as we say in our preview, we think that is misguided, it might not work.
Speaker: We lay out all of the reasons in the note.
Speaker: But if you're Jeremy Hunt and you read the report by the Institute for Fiscal Studies, which says this could save us £30 billion next year alone, I think it's got to be somewhat tempting.
Speaker: So, Danny, turning to you and with respect to the Bank of England, I guess a lot of people have this question of why did the Bank of England finish the emergency bond buying on the 14th?
Speaker: So essentially what the Bank of England was trying to do was to try and shore up markets and provide some stability to essentially buy time for pension funds to get their liquidity challenges addressed.
Speaker: And, you know, what that period of two or so weeks of purchases has done has enabled them to do that to some extent.
Speaker: You know, that's not to say that we're now definitively out of the woods.
Speaker: And certainly if we were to see a further sharp rise in interest rates again in the next few weeks, it would certainly put them to the test again.
Speaker: But certainly early signs are encouraging and market conditions have been a lot more stable since the end of last week.
Speaker: Perhaps even more surprising is not only have they stopped the bond buying, but they're going ahead with QT or quantitative tightening.
Speaker: Were you surprised by that?
Speaker: That certainly took some people by surprise, but actually almost in contrast to what most others were saying, we were actually very encouraged by this.
Speaker: We were thinking it was neither desirable or necessary for them to delay again.
Speaker: And actually, you know, very much in line with our view, they have announced just a very short delay.
Speaker: So obviously they were supposed to be starting on the 31st of October, the day of the budget.
Speaker: So obviously not a good idea.
Speaker: And they pushed that back one day to the 1st of November.
Speaker: But where they have made another very sensible change is to skew the sales.
Speaker: So previously they were going to be selling gilts in the short maturities, the mediums and at the long end as well, which is, of course, where they have just been buying.
Speaker: But now they have decided to just be selling gilts towards the shorter end of the curve.
Speaker: Let's turn to the currency side of things.
Speaker: Dom, the currency tends to be the great shock absorber.
Speaker: And whilst I was watching Liz Truss with her resignation statement that sterling appeared to strengthen it, is that going to last?
Speaker: So look, we think Sterling's probably going to struggle to find meaningful support from this announcement.
Speaker: Really what we've been thinking about is how you characterize the currency in terms of a structurally driven currency or a cyclically driven currency.
Speaker: And one of the challenges or the big challenge Sterling faces is that
Speaker: it still faces downward pressure on both of those fronts.
Speaker: So from a structural perspective, the budget, the mini budget, I should say, raised all these concerns about imbalances, both domestic and external imbalances.
Speaker: And that effectively has required moves in the currency as well as, you know, higher rates to kind of help stabilize some of those imbalances.
Speaker: So even if we go to a world with, you know,
Speaker: more fiscal restraint under whoever the new prime minister may be and with the budget on the 31st of October, that structural story, that may improve a little bit, but actually you end up worrying about the cyclical story after that.
Speaker: And the cyclical story in the UK is still very, very challenging in terms of very weak growth and high inflation.
Speaker: So it's very difficult at the moment to really see why sterling should sustainably rally because structurally there's still these big challenges to overcome and cyclically
Speaker: the picture isn't really improving.
Speaker: And of course, we're kind of looking at the domestic situation.
Speaker: But in terms of currencies, it's also what's happening with other currencies.
Speaker: And in this situation, the dollar remains continually strong.
Speaker: Is that likely to make the situation more difficult for sterling?
Speaker: Yeah, absolutely.
Speaker: From the other side of the equation, the dollar story remains very firmly intact.
Speaker: You've got a situation where the Federal Reserve in the US is able to keep hiking rates more aggressively than most of its peers because of the nature of inflation, which is much more domestically driven in the US.
Speaker: That's pushing, you know, generally US rates higher.
Speaker: That's dragging the dollar up.
Speaker: And until those conditions change more meaningfully, it is it's hard to see the end of the dollar rally.
Speaker: I mean, we did write in our recent currency outlook
Speaker: that we could be getting towards that peak.
Speaker: We need to be thinking about the catalysts which could start to see the dollar roll over.
Speaker: So once we get to that Fed pivot point, yes, we might start to see signs of dollar weakness emerge, but we're not there yet.
Speaker: It's still too early to call that peak in the dollar.
Speaker: And as long as the dollar remains strong, then it's going to be very hard for sterling to perform well on the other side of that.
Speaker: Thanks, Dom.
Speaker: So you mentioned the sort of structural issues associated with the weakness in sterling.
Speaker: So Liz, I just wanted to just recap on this funding gap that we're looking at.
Speaker: Just remind us the sheer extent of it.
Speaker: So lots of moving parts here.
Speaker: We don't know what the tightening policies the Chancellor might bring, but our central case as we lay out in the preview, we expect the Office of Budget Responsibility to forecast an extra £100 billion, both this year and next, and total borrowing next year of £155 billion.
Speaker: And Danny, can the government raise those funds?
Speaker: Quite frankly, the outlook for the supply of guilt is daunting and we're expecting a new record high of guilt supply for next year.
Speaker: And that really comes at a time when the appetite for guilt has been very weak and the political backdrop is still very uncertain.
Speaker: Well, on a rather cautious note, thank you, Liz.
Speaker: Thank you, Danny.
Speaker: And thank you, Dom, for your comments.
Speaker: I'm sure we'll have you back in the studio soon.
Speaker: But thanks for joining us today.
Speaker: Thank you.
Speaker: Thank you.
Speaker: Thank you.
Speaker: So that's all from this special edition of the podcast.
Speaker: From all of us here on the team, thanks for listening.
Speaker: We'll be back again next week.
