As we have seen over the last few days, market turmoil and volatility are very much top of the agenda. The chancellor’s ‘mini’ budget last week resulted in major volatility and uncertainty with markets still reacting nearly a week later. This is a worrying climate for investors, but is exactly the type of environment that Smoothed Managed Funds are designed to cushion against. Large movements in gilt yields and sterling; global markets watching for contagion risk. These contrast starkly with smoothed funds that continue to provide a stable and sustainable return for investors. In this short note, produced by Columbia Threadneedle Investments, in partnership with LV=, we summarise the reaction to the UK Growth Plan 2022 announcement, and outline what it means for investors in our Smoothed Managed Funds. 

In summary:

• On Friday 23 September the government revealed a Growth Plan for the UK economy, involving tax reductions, cancelling the recent increase in National Insurance and the planned increase in corporation tax, and reducing stamp duty on property purchases. 
• The markets reacted and Sterling fell to its lowest level against the dollar since 1971, prompting the Bank of England to announce it would buy long-dated UK government bonds in an attempt to stabilise the market. 
• Investors in the Smoothed Managed Funds can be reassured that ahead of the mini budget announcement, the portfolios were defensively positioned in UK government bonds and favouring equities outside the UK, and are well placed to take advantage of opportunities which could arise.

On Friday 23 September, Chancellor of the Exchequer Kwasi Kwarteng revealed[1] a Growth Plan[2] for the UK economy. Described as a “mini budget”, the majority of concrete policy announcements involved tax reductions: cancelling the recent increase in National Insurance and the planned increase in corporation tax, and reducing stamp duty on property purchases, had been widely trailed in advance. Subsequent headlines, however, focused on some much less costly changes announced on the day. These were a 1% reduction in the basic rate of income tax, brought forward from 2024 to 2023, and two politically toxic abolitions: of the 45% additional tax rate levied on incomes over £150,000 – which saw a late u-turn a little over a week later (03 October) - and of the 200% cap on bankers’ bonuses.

The Bank of England’s Monetary Policy Committee had increased its policy rate by 0.5% on the day before the chancellor’s announcement[3]. While the MPC was able to allow for the (downward) inflationary impact of the Energy Price Guarantee, it had to defer considering the (upward) impact of the Growth Plan on demand and inflation until later in the year. There is now a real prospect of monetary authorities raising interest rates higher than previously expected to reduce demand and inflation at the same time as fiscal policy is pulling in the opposite direction and trying to boost growth. Also likely is that inflation will now remain above target for longer, hence interest rates remaining elevated to bring inflation under control. 

The government now describes economic growth as its central mission. Increasing trend growth from the pre-pandemic level of 1.8% to 2.5% per annum is its primary economic objective. Tax cuts alone cannot achieve this. Although the chancellor paid lip service to supply-side reforms and fiscal responsibility, this was largely aspirational with much less detail than the tax cuts. Since the largest reduction in taxes since 1972[4] was announced outside of an official budget, there was no accompanying budgetary projection from the Office of Budget Responsibility (OBR). How, or indeed whether, this government plans to meet its stated aim of reducing debt as a percentage of GDP over the medium term will remain a mystery until updates are provided alongside the OBR’s forecast, which is now due by the end of the year.

The markets are in no mood to wait. Developing plans which involve very significant borrowing, the lack of OBR scrutiny and fiscal projections, and not sharing the budgetary plans with the Bank of England in advance all served to erode investors’ confidence in the macro-economic stability of the UK. The government expect borrowing in the current tax year (2022-23) to increase from £162 billion to £234 billion. Gilt yields of all maturities jumped by 0.5% over the course of the day (23 September), with further upward moves on Monday 26 September. Sterling has fallen to its lowest level against the dollar since decimalisation in 1971. These are enormous moves, and prompted the Bank of England to announce it would take urgent steps to buy long-dated UK government bonds, beginning immediately, in an attempt to stabilise the market. Market pricing currently implies a consensus that base rates will be increased by a full percentage point at the MPC’s next meeting.

The Growth Plan did contain measures, or ambitions, beyond just tax. Discussions are underway to set up 38 investment zones across the country, with streamlined planning rules alongside tax breaks. On the energy front, the government seeks to decouple the price of electricity from that of gas, and to increase the UK’s homegrown supply of energy. As well as accelerating the use of fossil fuels (oil and gas from the North Sea and from fracking), it plans to remove the 2015 Conservative government’s amendment to planning rules which had the (desired) effect of stopping all new onshore windfarms. The lack of green ambition is exemplified by road projects making up well over half of the infrastructure schemes being accelerated[5]. Finally, the chancellor sought to burnish his Brexit credentials with a deregulation agenda: the Growth Plan makes more references to scrapping EU rules than it does to implementing fiscal rules[6].

Active risk taking in the Smoothed Managed Fund portfolios has been low of late, mainly driven by the uncertainty surrounding geopolitical and macro events and announcements. In advance of the Bank of England and the mini budget announcement we were defensively positioned in UK government bonds and favouring equities outside the UK. As such, the Smoothed Managed Fund portfolios are well placed to take advantage of opportunities which could arise both in quality companies as well as broader global assets.

[1] https://www.gov.uk/government/speeches/the-growth-plan-2022-speech
[2] https://www.gov.uk/government/publications/the-growth-plan-2022-documents
[3] https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2022/september-2022
[4] https://ifs.org.uk/articles/mini-budget-response
[5] 86 out of 138. See: https://www.gov.uk/government/publications/the-growth-plan-2022-documents
[6] Five versus two. See: https://www.gov.uk/government/publications/the-growth-plan-2022-documents