Weeks ahead of Halloween, the UK received something of an unseasonable fright, writes Norman Chambers, managing director of the National Association of Commercial Finance Brokers. (This article first appeared in the NACFB’s Commercial Broker magazine)
After a ‘fiscal event’ that was more trick than treat, the markets plunged into freefall. What followed was a hair-raising run on sterling, a sharp rise in bond yields and a stinging public rebuke from the IMF, as financial markets reacted negatively to unfunded tax cuts that favoured the rich and an energy package that is bigger than both the 2008 bank bail-out and 2019 furlough scheme.
Were it not for the Bank of England’s intervening to buy bonds to support prices, there would have been pension fund companies declaring bankruptcy, as their liabilities would have been greater than their assets. Such a ‘doom loop’ of falling assets would have forced pension funds to sell assets to raise cash to compensate, but as buyers dried up, prices fell. Thus, they were mere hours away from being dead and buried before the Bank of England stepped in.
Just what had brought us to this point? How on earth do we move beyond it, and how will this volatility impact a small business community already feeling the pinch?
An ideological shift
When tasked with writing a monthly feature, I am reminded that assessing macroeconomic activity can be viewed as academic or fanciful, with most of the NACFB membership concerned with matters closer to the micro end of the spectrum. However, I believe it would not be very responsible on this occasion to ignore the complex web of conflicting forces in the commercial broking market. The commercial lending sector doesn’t operate in a vacuum, and, as evidenced by events of late, an unexpected fright can reverberate widely.
We shan’t focus too much on the who’s and how’s of Chancellor Kwasi Kwarteng’s first mini-budget because, by now, there is near universal agreement that it resolutely spiked the punchbowl. The reaction to it – and the chain of events that followed – is of more interest, for seldom can you draw such a short and direct line between political decisions and real-life consequences. The crux of the concern for many, including the IMF and a few global rating agencies, was the apparent shift in economic policy displayed by the new administration compared with that of the last 12 years of Conservative governments.
The package of measures aimed to boost economic growth by cutting taxes and regulations, funded by vast government borrowing and included a proposal to scrap the top 45% income tax rate paid on earnings above £150,000 a year. But the plan triggered a crisis of investor confidence in the government, jolting global markets to such an extent that the Bank of England had to intervene with a £65 billion program to shore up the bond market. Even as it succeeded at this, the damage had been done. Bond yields were significantly higher, raising mortgage rates and immediately impacting the many thousands who were refixing or entering new deals.
The resultant – and somewhat inevitable – government U-turn followed immense pressure from the market and conservative backbenchers. It represented an embarrassing climb down from what should have been a flagship policy. Chancellor Kwarteng said the proposal to slash the top rate – which made up about £2 billion out of the overall £45 billion tax-cutting plan – had: “…become a distraction from our overriding mission to tackle the challenges facing our country.” An array of investors and economists welcomed the reversal but cautioned that the government needed to go further still.
The government had been due to release another fiscal statement with the full scale of borrowing and debt-cutting plans in late November – but this had been brought forward to the 31st of October – where at least the next set of tricks and treats will enjoy a more familiar Halloween backdrop.
Going for growth?
Perhaps not unreasonably, as both party leaders took to their respective conference stages, there was a central theme to their headline addresses, the drive for economic growth, something that all parties want. But Britain’s economy is expected to remain weak or be in a mild recession until 2024, which is likely to leave the UK’s output level below its pre-COVID peak seen in Q4 2019. Despite relatively low unemployment and high job vacancies, business investment, households, and businesses will struggle with soaring costs.
September saw a significant decline in key indicators of economic activity, with confidence among company bosses over the growth outlook collapsing to the lowest level since the pandemic and consumer confidence at 1974 lows. In a downbeat assessment, analysts at Deutsche Bank said UK GDP was due to take until 2024 to return to the level of December 2019 before the pandemic struck, raising the prospect of five years of stagnation.
The Prime Minister used her speech to the Conservative party conference in Birmingham to argue that her government would prioritise “Growth, growth, growth” while attacking what she called an “anti-growth coalition” that could hold the country back. The PM continued her push to break the “high-tax, low-growth cycle” by offering lower taxes and scrapping regulations to encourage companies to invest more in the UK economy and households to spend more. Still, with weaker global growth since Russia’s war in Ukraine began, the Bank of England forecasted in its August monetary report that the UK economy will shrink for five consecutive quarters starting in Q4 this year.
At the sharp end
Highlighting the risks to the economy with inflation at a 40-year high, the British Chambers of Commerce (BCC) also shared that more than three-quarters of companies it surveyed had not increased investment in the last quarter. The BCC outlined a sharp drop in business confidence in the past three months in its study, though this was before the government announced its energy support package and mini-budget plans. However, worryingly, as many as four in 10 firms said in that report that they thought their profitability would fall in the next 12 months.
Shevaun Haviland, the director general of the BCC, said that, while the government’s support measures were welcome, ministers urgently needed to present more detail on how their policies would support firms to expand. “Our findings paint a worrying picture of the state of affairs at many UK firms. Almost every key business indicator is trending downwards – sounding alarm bells across all sectors and regions,” she said.
It is a testament to the continued resilience of small businesses that they have been repaying bank debt over the last five years. Bank of England figures show the annual growth rate of lending to SMEs is negative, with small firms making net debt repayments of close to £1 billion in March alone. Lending to big corporates, by contrast, has increased significantly since the start of the year. According to the FSB‘s Small Business Index, fewer than one in 10 small firms applied for finance in Q1 2022, the lowest proportion since SBI records began. The share that saw applications approved (43%) was also at a record low.
Against this landscape, NACFB members will likely see an increase in distressed borrowing over the next six months as by-standing SMEs become more likely to be entangled in the complex web of macroeconomic forces. Commercial finance intermediaries of all specialisms should now seek to partner with existing clients and enterprises with high levels of debt and work with them to lengthen loan terms and consolidate where possible.
Now is the time when members can be adding real value to their clients. By restructuring existing debt and examining alternative debt structures, finance professionals can help shore up their clients in the short to medium term, enabling them to ride out periods of economic turmoil and return to growth.
The tussle at the top
PM Liz Truss and her Chancellor were asking the country to believe the most significant obstacle between the economy and growth was excessive taxation and too much regulation. But the financial markets and the IMF begged to differ and disagreed with their approach.
What was presented was a plan explicitly at odds with the Bank of England’s policy position of keeping inflation down. They had raised interest rates and initiated a ‘quantitative tightening’ round to slow the economy. That required taking money out of the system – quite the opposite of the government’s efforts to spur growth by cutting taxes and thereby hoping to stimulate growth. This means the Bank of England will raise interest rates at its next meeting by more than it would otherwise. Historically, it is not unusual for the mix of fiscal and monetary policy to differ. But we have had a loose monetary and loose fiscal policy stance for 14 years, and we have grown accustomed to it.
Sharply higher price inflation at 40-year highs has now changed this mix, with the policy priority for the Bank of England to reduce inflation. It must now raise interest rates to do that and meet its legal mandate to keep price inflation low and table at around a 2% annual rate in the medium term. Its role is not to do the government’s bidding on monetary policy. This is why it was made independent in 1997 with a mandate from the government to act at arm’s length. This was thought – and still is by financial markets and investors worldwide – as the best way to add credibility to monetary policy, free of political influence.
Any move by the government to change this would result in a deep financial, international investor, and political crisis that would dwarf any seen thus far, and the Bank would not be able to help as it would have been hamstrung. Moreover, it would require an act of Parliament, and many Conservative MPs would never vote for such a thing, never mind the implacable opposition of MPs from every other party.
For a government that needs to borrow money from international investors to fund its energy plans and tax cuts, it would be political suicide to change the Bank of England’s remit. That is because the view widely held amongst academics and financial market practitioners is that low and stable inflation aids growth and promotes employment. That is because it gives certainty to investors planning for the longer term and protects those low incomes from the debilitating effects of inflation.
Therefore, we are in for a future of loose fiscal and tight monetary policy. That is something that businesses and households will have to get used to for the first time in decades, and it may be a difficult adjustment. But we must start now.