Market Special – Currency Update

We argued in our Weekly Market Summary that there was little surprise in last Friday’s (23 September 2022) mini-budget from the Chancellor of the Exchequer, Kwasi Kwarteng – however, the reaction by the financial market and the media has been a big surprise, in particular the fall in the value of the pound and UK gilts.

As an aide-mémoire, the overwhelming majority of the “tax cuts” had not only been a key part of Liz Truss’ election campaign, but were actually simply the reversal/cancellation of planned tax rises (which were themselves criticised by the media and markets when they were announced by the then Chancellor, Rishi Sunak), while the 1p reduction in the basic rate of tax was already announced – albeit planned for April 2024 rather than April 2023.

The only real surprise was the decision to scrap the 45p rate of income tax for those earning over £150,000 – but this will cost, at most, just £2bn annually (and it should be noted that when George Osborne cut the additional rate from 50% to 45% in 2012, it was seen as a misjudgement, but the Inland Revenue actually saw the highest earners pay an additional £8bn of tax).

Instead, we believe (as we highlighted in our Weekly Market Summary), this weakness is more to do with the government’s focus mainly on tax cuts – as Kwasi Kwarteng made no attempt to set out a strategy to bring down debt.

Additionally, while the pound has fallen in value this morning (Monday 26 September 2022), this is predominately due to US dollar strength, as we have seen similar weakness in other currencies, including the Euro.

In fact, the US dollar has gradually been gaining strength relative to other major global currencies for several months.  Some of this is due to global uncertainty (caused by the war in Ukraine), as the dollar is seen as a safe haven which means it tends to strengthen in times of uncertainty, and some is due to the Fed’s monetary policy.

Last week Fed policymakers not only increased US interest rates by 0.75%, but they made it clear that they will continue to increase interest rates to tame inflation – which simply sped up the dollar’s appreciation.

As for today’s move in UK gilts (bonds), yields have risen sharply (meaning prices, which move inversely to the yield, have fallen), this is due to the rapid re-pricing by financial markets that BoE policymakers will speed up the pace and size of UK interest rate increases as a result of the government’s fiscal policies.

We stated in the Weekly Market Summary, financial markets were expecting the BoE to increase UK interest rates by 1% when they next meet on 3 November 2022.  Well that has all changed this morning, as financial markets are now pricing in an interest rate increase of 1.5% – with many economists forecasting that the BoE will implement this increase well before 3 November 2022.

However, what is bad for the pound is good for the FTSE-100 as around two-thirds of the FTSE-100’s total revenue is derived from abroad, and so a weak pound is positive for the FTSE-100 as it increases returns for exporters and the value of overseas earnings – hence why the FTSE-100 was among the best performing equity markets first thing this morning.

Investment Management Team

The latest market updates are brought to you by Investment Managers & Analysts at Wealth at Work Limited which is a member of the Wealth at Work group of companies.

Links to websites external to those of Wealth at Work Limited (also referred to here as 'we', 'us', 'our' 'ours') will usually contain some content that is not written by us and over which we have no authority and which we do not endorse. Any hyperlinks or references to third party websites are provided for your convenience only. Therefore please be aware that we do not accept responsibility for the content of any third party site(s) except content that is specifically attributed to us or our employees and where we are the authors of such content. Further, we accept no responsibility for any malicious codes (or their consequences) of external sites. Nor do we endorse any organisation or publication to which we link and make no representations about them.