Markets seem to have welcomed the change in leadership and appointment of Rishi Sunak as Prime Minister following an extremely turbulent couple of weeks which saw the (not so) mini-Budget sent domestic markets into panic as concern regarding the UK’s fiscal sustainability spread. This month has seen sterling rebounding from its $1.03 low and trade at around $1.12 against the US Dollar. In addition, 30-year government bond yields have retreated by around 125 basis points from their peak and UK equities have started to recover losses. This cannot all be attributed to the new Prime Minister; confidence was also boosted by new Chancellor Jeremy Hunt axing much of the ‘mini’-Budget, as well as the Bank of England’s intervention in the gilt market which helped calm the sell-off.

The vast fiscal expansion proposed by former Chancellor Kwasi Kwarteng resulted in markets sharply repricing interest rate expectations, at one point pricing in a peak of over 6%. This was fuelled by the expectation that the Bank of England would have to raise rates even more aggressively to counteract the inflationary impact of the extra fiscal stimulus over the medium-term. With the recent change in fiscal stance, however, markets have deemed that a lower peak rate is appropriate, now below 5%. Considering the deteriorating economic environment, we judge that the Bank rate will not need to rise even as high as this, with a peak of around 4% sufficient to pull inflation towards the 2% target. Bank of England Deputy Governor Ben Broadbent has commented himself that the curve is too steep, supporting this view.

At its latest meeting, the Monetary Policy Committee (MPC) was faced with a difficult decision on the appropriate path for the policy rate. Inflation has now been above the 2% target for over a year, but this could decline more rapidly if the suggestions that the delayed Autumn Statement – now set for 17 November – could include substantial fiscal tightening are correct. Ultimately, the MPC could only react to the information it had at hand, which did not include the full details of the fiscal statement. As such the committee increased the Bank rate by an unprecedented 75 basis points to 3.00%, as expected, with high inflation the driving force behind the outsized hike. A three-quarter point hike is likely to be an exception, however, rather than the norm moving forward, with Governor Bailey stating that although the Bank rate may have to go up further, it will have to go up by less than is priced in by markets.

With the appointment of Rishi Sunak as Prime Minister and Jeremy Hunt as Chancellor we hope that much of the political turmoil is now behind us. There are still a few key events on the calendar though that warrant attention, the key one being the previously mentioned Autumn Statement on 17 November 2022, with the accompanying forecasts from the Office for Budget Responsibility. The Chancellor has expressed his intention to ensure debt is falling as a share of GDP over the medium-term and reaching this aim would likely require tax rises and probably some squeeze on public spending. A spokesperson for Sunak has stated that no tax options are off the table for the Autumn Statement. The question is how far the new Prime Minister and Chancellor are willing to go to ensure fiscal sustainability.

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