Following what has been described by some media pundits as a fairly muted reaction to the details of the UK government’s U-Turn, the details of which were announced by the new chancellor Jeremy Hunt during a statement made on Monday 17 October, it is clear that the stock market, the Pound and even government borrowing costs are now not where they were prior to the mini-budget announced by the former chancellor, Kwasi Kwarteng.
London Business School’s Professor Richard Portes appeared on Times Radio on Tuesday 18 October to discuss the future fortunes of the UK economy with Times Radio’s Dominic O’Connell.
Within this challenging environment Professor Portes was asked why the yield on 30-year gilts have not returned to their values before the mini-budget crisis began.
Professor Portes’ response drew, in part, on an interview with Sir Peter Bottomley immediately prior to his own interview: “It was interesting to hear Peter Bottomley pretending we could go back to the status quo ante. [However], once you have lost a reputation that has taken a long time to build, it is very hard to rebuild that reputation. And so the credibility of any UK government now is somewhat impaired, and that will show up in the bond markets.”
One of the underlying problems in the UK economy that were revealed by, in Professor Portes’ words, “this step into the unknown” (the UK government’s mini-budget), was the amount of hidden leverage in UK pension funds*. At present pension funds are still having to sell gilts (in the wake of the mini-budget). “Those underlying factors are now worse than they were before this failed experiment,” comments Professor Portes.
Journalist Dominic O’Connell asked Professor Portes, ‘What will bond investors want to hear from Jeremy Hunt on October 31, and from the Office for Budget Responsibility?’
Professor Portes’ response is as follows: “I fear that they will want to hear about (too much) fiscal tightening, and the possibility of going back into a period of austerity, which led to so much suffering and so much economic dislocation in the past, so that is what the bond markets will want and that is only because we embarked on this disastrous experiment. So that is where we are now. We cannot expect a return to the status quo ante and indeed the cuts in government funding may eventually go too far given the reality of the situation. Now we have a new chancellor and new policies, and even the wholesale reversal of ‘Trussonomics’”. However, I fear that this may not be enough to address all of the problems we see unfolding”.
*Contractual pension promises are a form of debt. The employer owes employees a sum in the future and this rises with long-run inflation expectations, as retirees’ incomes are typically linked to consumer prices. It also jumps with advances in the longevity of populations, as pensions then have to be paid for longer. It is worth noting that there has been a welcome increase in corporate disclosures regarding how pension pledges are calculated, driven by new regulations. Pension operators’ annual reports have details of the estimated cost of paying pensions. IAS 19, the accounting standard for employee benefits, demands companies set out the risks in a pension plan that could affect their cash flows. But the one-size-fits-all guidance is necessarily general rather than overly specific. Unfortunately, the assets set aside to meet the liabilities have not received so much attention until recently. For further perspectives on this, read How Could So Much Pension Leverage in the UK Lurk Unseen?