British assets jump after U-turn on fiscal plans

A general view of the Bank of England (BoE) building in London, Britain
A general view of the Bank of England (BoE) building in London, Britain, August 4, 2022. REUTERS/Maja Smiejkowska
  • Yields on gilts fall around 40 basis points
  • Pound jumps 1.7% on dollar, 1% on euro
  • British stocks rise more than European peers
  • Investors eye next fiscal announcement due end Oct. and Bank of England meeting early Nov.

LONDON, Oct 17 (Reuters) - Britain's government bonds, currency and shares rallied on Monday as new finance minister Jeremy Hunt reversed much of Prime Minister Liz Truss's economic growth plan, the latest twist after several weeks of turmoil in UK politics and markets.

Hunt said the tax changes would raise 32 billion pounds ($36 billion) a year in extra revenues as he sought to end the chaos in the bond market that followed the government's previous plans for sweeping unfunded tax relief.

He also said the government's planned vast two-year energy cost support scheme would only run until April and would be reviewed after that.

Investors said that while Hunt's changes were welcome they had only returned Britain to where it was in late September, with its economy still in a precarious state and now led by a weakened prime minister.

"Hunt has trod the narrow gap between political imperative and economic imperative, and he's done so well at this stage," said James Athey, investment director at abrdn.

"But we don’t think this really takes UK plc completely out of the woods. You’re still talking about an almost inevitable recession which will be accompanied by high inflation," Athey said. "That looks stagflationary, which is a very uncomfortable place to be."

UK gilt yields, which move inversely to prices, held lower after Hunt's statement. The 30-year yield was last down over 40 basis points at 4.37%, the 20-year fell a similar amount to 4.45%.

They were set for some of their biggest daily declines on record, after the strong drop on Sept. 28, when the Bank of England stepped in to stabilise Britain's bond market in the wake of the turmoil triggered by the growth plan unveiled in a so-called mini-budget.

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However, such a historically huge rally for gilts, on Monday only returned long-dated yields to levels seen last week - a reflection of the enormous volatility gripping markets recently.

The pound soared 2.2% against the dollar to $1.1418, also boosted by the weaker U.S. currency. It strengthened against the euro too and hit its strongest level in nearly six weeks.

The European common currency was last 0.74% lower at 86.39 pence.

London's FTSE-100 (.FTSE) closed 0.9% higher, and the FTSE-250 (.FTMC) index of domestically focused mid-caps rose 2.76% outperforming a 1.8% rise in the European STOXX benchmark (.STOXX)

UK gilts and sterling


Following Friday's sacking of previous finance minister Kwasi Kwarteng and Monday's announcement by his successor, investors and traders were shifting focus to the next steps - including a medium term fiscal plan due on Oct. 31.

"It's all back to where we were before Kwarteng and before the mini budget but still uncertain in terms of where we go forward, how long Truss remains in place and what he (Hunt) will unveil," said Peter McCallum, rates strategist at Mizuho.

Suggesting further bumpy ride ahead, the Institute for Fiscal Studies think tank calculated last week Britain had a budgetary gap of 62 billion pounds, nearly double the increase in revenue announced on Monday.

Goldman Sachs also revised down its 2023 UK economic output forecast to a 1% contraction from an earlier forecast for a 0.4% output drop in what would be a "more significant recession," it said in a note on Sunday.

This matters for markets globally, given the pound's high volatility and the moves in the exchange rate and the British yields affecting other currencies and government bond markets.

Speculators increased their exposure to the pound by a fifth in the latest week - the most in two months, according to data from the Commodity Futures Trading Commission.

All eyes are now on the Bank of England, with money markets now seeing a 66% chance that it will raise rates by 75 basis points on Nov. 3 after pricing indicated a near certainty of such a rise just a couple of weeks ago.

"The implication for the Bank of England is that with a tougher fiscal stance monetary policy action can afford to be less aggressive," said Nomura analysts.

Political uncertainty also remains, with bookmakers' pricing indicating a roughly two thirds chance Truss will no longer be prime minister by the end of the year.

"Gone are virtually all the unfunded tax cut promises from the previous Chancellor and markets are of the view that soon so too will be the original architect of the failed mini-Budget” said Charles Hepworth, investment director at GAM Investments.

Reporting by Alun John,Andy Bruce and the London markets team; Editing by William Schomberg, Ed Osmond, Alex Richardson and Tomasz Janowski

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