by Simon Derrick
Investors have been presented with a series of headlines over this weekend that they will need to consider carefully as they think about the prospects for the Pound and UK markets in the coming weeks.
The first of these was Chancellor Kwasi Kwarteng’s apparent lack of concern about the slide in Sterling, telling the BBC on Sunday morning that he doesn’t comment on market movements, that he wants to look at the medium- and long-term picture for growth. This was hardly contentious in following a path well-trodden by previous Chancellors. However, it did inadvertently also highlight that there is relatively little he could do about the slide even he wanted to.
On the face of it the UK government and BOE’s $202,29 Bn in international reserves sounds like a substantial war chest with which to defend Sterling should it become necessary. However, it is worth putting this into context. When Japan’s Ministry of Finance launched its intervention campaign in late 2011 to combat what it saw as excessive Yen strength it spent JPY 8.072 Tn on the first day of the campaign alone, that’s just over $100 Bn. Although the operation certainly proved successful, the sheer scale of the operation made clear that only “shock and awe” can really work given the scale of modern markets. Moreover, the MOF was of course selling Yen and therefore had in effect an unlimited supply of ammunition. With this in mind, along with distant memories of the failed attempt 30 years ago to keep the Pound in Europe’s Exchange Rate Mechanism, relative insouciance is probably the only realistic stance the Chancellor can take at present.
The second headline of note was that the UK government fully intends to make further tax cuts in a full budget next year. Given that Friday’s sell off for both the Pound and Gilts was triggered directly by the Chancellor’s announcement of a package of measures amounting to £45 Bn in tax cuts, this is hardly what investors will want to hear. However, with a week being a long time in politics it’s perhaps fair to say that floating plans for tax cuts six months hence might not have that meaningful an impact on markets when they re-open, although it can hardly help.
The third headline (in The Daily Telegraph) was that “both supporters and critics of the Prime Minister on the Conservative benches” believe a decline in the Pound below parity with the Dollar would be the trigger for some MPs to withhold their vote on the government’s finance bill or even submit letters of no confidence. No mention was made of the number of possible rebels, and it is also worth highlighting the government’s current working majority of 71. So, it would take a swing of 36 Conservative MPs for the finance bill to be defeated when it finally comes to the House of Commons (which may not be until next year). Given that, by convention, budgets are considered to be confidence matters, the government must resign if it is defeated.
This might sound somewhat far-fetched given the current polling numbers and that turkeys don’t typically vote for Christmas. However, much will depend upon how markets respond over the next few weeks and how, in turn, it is portrayed in the UK press. MPs will be mindful of the negative coverage the UK’s exit from the ERM garnered in 1992 and of the impact similar reporting could have on the voting public. The question for them will then be whether to hang on for another 18 months or so in the hope things improve or to roll the dice immediately on the grounds that the situation is only going to deteriorate from here. This really leaves one question: will investors be prepared to wait to find out what happens next?