ALEX BRUMMER: Sterling’s rebound hopes

It should come as no surprise that the financial markets have misunderstood Kwasi Kwarteng’s fiscal event. The pound, which has fallen since Boris Johnson was evicted from Downing Street, is suffering from political instability, according to traders.

Britain has a reputation for fiscal discipline, so the move by the Liz Truss government to ease the wallet caused turmoil in sterling and gold.

There are no formal figures on the impact on public finances, but figures from the National Institute of Economic and Social Research claim that higher spending (mainly to save the energy market) and tax cuts will increase the government deficit by as much as £150 billion.

That would bring Britain’s public debt as a percentage of national output to 91.6 percent in 2024-25 – against an expected drop to 87.6 percent of GDP.

This may feed the tale of doomsayers, but it’s worth remembering that at such levels it is significantly lower in debt than the US, Japan and Italy, all of which are in the stratosphere. It is also lower than France, which has an economy not much different from ours in size and structure.

As a free-floating major currency, sterling has been an easy ride for speculators during a period of uncertainty. Obviously, no one wants to see the pound trade at $1.08, where it’s close to the 1985 low.

What is often forgotten, however, is that as Thatcher’s reforms continued, sterling returned to the $2 level in 1990. In the world of foreign exchange, nothing lasts forever.

Traders argue that Britain has become politically unstable since the 2016 Brexit referendum. Yes, there have been four prime ministers. But they are all from the same party, which was elected with an 80-seat majority in 2019. Compare this, for example, with Italy and Sweden, where neo-fascist parties have or will soon have a role in government, and France, where the far right has 89 seats in the National Assembly.

That’s something markets should really be concerned about.

UK financing needs are set to explode in the coming months. The Debt Management Office has the daunting task of raising a further £72.4 billion in the current fiscal year.

This comes at a time when the Bank of England plans to sell £80bn of its £900bn in quantitative easing over the next 12 months.

At the beginning of the summer, when Boris Johnson was on the ropes, the yield on the two-year gold was 1.7 percent. Before Kwarteng’s event, the return was 3.4 percent and in last trade it had reached 3.9 percent.

How concerned should we be?

The death of Queen Elizabeth II brought hundreds of world leaders to London. Among those in attendance were many Gulf rulers who have long been on British bonds and property and are still lenders.

Norwegian oil funds have favored London over their Nordic neighbors and at current levels UK bonds should start to look more attractive to less clingy investors.

One thing is certain: with inflation near or near double digits, Kwarteng should not follow the example of its predecessors and sign more index-linked bonds. Tying 25 percent of UK debt to retail prices was a major blunder.

freedom pass

The Chancellor’s mini-Budget wasn’t quite the ‘Big Bang 2.0’ predicted, but the direction of travel is clear.

Instead of hiding the lifting of the limit on banker bonuses in the fine print, Kwarteng tried to make a refreshing virtue of it.

Being able to lift the limit is a Brexit dividend. As much as people loathe ‘fat cat’ bonuses, the freedom to set prizes for achievements will fuel the prosperity of the Square Mile and Canary Wharf.

It will also pay off the debt, as financial services are a rich source of tax revenue, helping to fund the NHS and welfare.

Likewise, the decision to make it easier for pension funds to invest in illiquid assets, such as infrastructure and start-ups, should be positive.

Less attractive is the idea that the funds could also invest more money in private equity.

The return can be attractive. But the destructive power of private equity, as seen in care homes, retail and defense industries such as space pioneer Cobham, outweighs any benefits.