UK markets take Autumn Statement in stride

Investors gave a tentative seal of approval to chancellor Jeremy Hunt’s plans to repair the UK’s public finances, a stark contrast to the market carnage unleashed by the “mini” Budget of his predecessor Kwasi Kwarteng.

A sweeping package of £55bn of tax rises and spending cuts announced on Thursday had been broadly anticipated by financial markets, which had already been reassured by the comprehensive U-turn signalled by Hunt and Prime Minister Rishi Sunak from the £45bn of unfunded tax cuts announced under former prime minister Liz Truss.

UK government bonds, which had been plunged into crisis by Kwarteng, weakened slightly, unwinding a small part of a strong rally in recent weeks. The pound fell 1.1 per cent against a resurgent dollar to trade just below $1.18, but the currency remained far above September’s all-time low of less than $1.04 and not far short of a recent three-month high.

“This is a massive contrast to what we saw in Kwarteng’s budget,” said Mohammed Kazmi, a portfolio manager at Union Bancaire Privée. “The big rally in the run-up and a relatively muted reaction today suggests this government has restored UK credibility in the eyes of the market.”

Gilts came under modest pressure amid global weakness in bond markets, pushing the UK’s 10-year yield 0.06 percentage points higher to 3.19 per cent, a long way short of September’s 4.5 per cent peak.

The involvement of the Office for Budget Responsibility, which presented fiscal forecasts to accompany Hunt’s plans — in contrast to Truss’s sidelining of the watchdog — also helped to reassure investors, said Jordan Rochester, currency strategist at Nomura.

“This budget has been designed as much as possible to avoid the potential for a big sterling or gilts move,” Rochester said.

The UK Debt Management Office said Hunt’s measures would result in a reduction in bond sales in the 2022-23 financial year to £170bn, below the figure of £194bn at the time of Truss’s ill-fated “mini” Budget in September and less than the £185bn expected by investors. However, although the DMO does not provide a gilt sales figure for the following year, the government’s financing requirement for 2023-24 was higher than that expected by markets at more than £300bn.

James Lynch, fixed income investment manager at Aegon Asset Management, said markets would struggle to price the “eye-watering” level of gilt sales on the way next year given issuance has been cut in the near term.

“Jeremy Hunt has delivered a budget which has not seen gilt yields go to the moon and the pound crater, so this is roaring success so far,” Lynch said. “But I would not be surprised that yet again in 2023 we will be talking about the market’s ability to absorb a large amount of gilt issuance.”

Investors also said Hunt’s return to austerity is likely to pile further pressure on an economy that is already in recession and set to shrink by 1.4 per cent next year, according to the OBR.

That means the Bank of England may struggle to raise interest rates as far as currently expected by markets, which should support gilt prices but undermine the pound, said Mark Dowding, chief investment officer at BlueBay Asset Management.

Traders are betting that the BoE will raise interest rates to 4.5 per cent by next summer as it battles inflation that soared to more than 11 per cent in October, an expectation little-changed by Hunt’s budget.

“Hunt has restored a measure of faith in UK assets, but at what cost?” said Dowding. “The outlook is just so bleak before you take into account today’s measures. I don’t think the BoE can hike much further without collapsing the housing market.”

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