The UK announced an unfunded, pro-growth fiscal expansion that led to a volatile drop in local currency and higher government yields. The plan's goal is to achieve a 2.5% trend economic growth rate in the medium term. If it fails to deliver promised growth rates, the risk of an early general election in 2023 will rise significantly. We recommend remaining underweight overseas equities, especially in Europe.
UK's newly appointed Prime Minister, Liz Truss, and the Chancellor of the Exchequer, Kwasi Kwarteng, announced a ₤45b mini-budget that included the biggest tax cuts in over five decades. The new government also aims to reform the economy by slashing regulations, setting up tax-preferred zones, and improving the attractiveness of Britain by offering low corporate tax rates. This ambitious program will be funded by borrowing, hoping that future economic growth will eventually pay its cost.
Program in a nutshell:
- Limiting the cost of energy – price guarantees for electricity and gas that would keep a typical household’s budget for energy around ₤2,500, a projected saving of over ₤1000 per year per household. Lower-income households will receive additional subsidies.
- The new government’s plan aims (over the medium-term) to reach a trend rate of real economic growth of 2.5% via expanding the supply of the economy through incentives and reforms.
- Lifting the cap on banker’s bonuses to strengthen UK’s attractiveness in the global financial services industry.
- Over 40 new investment zones are planned to attract new businesses to the UK. Corporate taxes will be lowered to the lowest level within G20 nations. National insurance contribution hike will be canceled, offering more stimulus to companies.
- Higher income earner’s tax rates will be reduced to 40% from 45%.
The British pound had been losing value against the U.S. dollar, and the new unfunded spending package pushed the pound further to historically low levels. The severe and rapid drop in the currency's value will usher in higher imported inflation as the country imports most of its energy and is going through a significant energy crisis due to a lack of adequate natural gas storage for the coming winter. The radical growth-oriented economic plan pushed the cost of borrowing as well. Expected additional borrowing could increase government yields, leading to even higher inflation in the near term with the cost of capital becoming more expensive.
British pound will reach parity against the U.S. dollar and Euro this year
When Liz Truss became the new Prime Minister of the UK, we expected that her expansionary economic policies could push the British pound to parity against the U.S. dollar before the next general election in 2024. The announced economic plan is much more expansionary than we anticipated. Therefore, we believe that the British pound will reach parity not only with the U.S. dollar but also with the Euro this year, much earlier than our initial take.
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