Kwasi or Reeves/ The choice is yours. TPP market commentary

Reeves or Kwarteng? Which of these two budgets would get your vote now?

Don’t laugh until you’ve read on.

A new Prime Minister, a new Chancellor and a big-hitting budget. It does sound familiar. Both going for ‘Growth’ but one wanted to cut taxes by around £40 billion and the other has raised taxes by £40 billion.

Britain's finance minister Rachel Reeves has faced criticism after her first budget came in big on spending, tax increases and borrowing but small on economic growth, which was one of the big election promises of the Labour Party.

The unveiling of the new government's economic programme by Reeves on Wednesday was accompanied by only tepid projections for growth and a grim outlook for living standards.

Employers have warned they will struggle to cope with the increase in social security contributions that form the lion's share of the extra 40 billion pounds that Reeves plans to raise in tax, the biggest increase in a budget since 1993.

"The increased business costs alongside the raft of changes planned to employment regulation, are bound to act as a headwind to growth," Ben Willmott, public policy head at the Chartered Institute of Personnel and Development, said.

The Budget has been getting a lot of press, and quite rightly so. It was huge. Lots of borrowing, lots of extra tax and lots of extra spending.

Do you remember the Budget announced by Lis Truss’s government? That was also a budget which promised growth. Can you remember what Kwasi Kwarteng wanted to do?

Of course you can’t. The actual ‘Growth Plan’ itself was somewhat lost in history due to it being overshadowed by the sell-off in the Gilt market, (which very few people genuinely understand the reasons for it and most politicians just irritatingly refer to as ‘the markets’ without any true knowledge of what happened).

Now the mini-budget has been mostly forgotten let’s have another look at what the then Chancellor Kwasi Kwarteng actually set out within its pages and how it would compare to the budget we got this week.

Two budgets promising growth, but that is where the similarities end. Sadly for Rachel Reeves, the Office for Budget Responsibility has now also announced that this week's budget will provide no extra growth over the next 5 years. So in fact, the latter was not a growth budget at all. As for the growth Kwarteng’s budget would have injected into the UK economy, we’ll never know, but we do believe it would have been significant had he remembered to fund it!

Before we have a look at the Kwarteng budget again, it’s important to understand the costs of both proposals. Kwasi Kwarteng made £45 billion worth of tax cuts to fuel the economy which he believed would be paid for with larger receipts via ‘The Growth Plan’. Higher revenues, more tax. He would also need to borrow in order to pay for these cuts. Sadly, he hadn’t informed the Gilt market or the OBR of just how much.

Rachel Reeves also intends to borrow more. She announced her intent to borrow an extra £32 billion which is why the Gilt market has once again sold off. Don’t let anyone tell you it hasn’t, or that it’s Lis Truss’s fault, it has and it’s not. ‘The Markets’ did not like the Budget.

Reeves will need to borrow less than Kwarteng as tax cuts are adding to the money she’s making available to spend, so the market sell-off is smaller. It was also expected and the market pre-warned, so the price of Gilts had already factored in a lot of the move.

Here is a graph showing the price action of the 10-year Gilt starting with the red circle of the Truss/Kwarteng budget up to today’s green circle after the Starmer/Reeves budget. You’ll notice that the yield is higher today even as interest rates have now started to drop. The recent movement has been on the back of the expectation of the announcement, and subsequently the actual budget announcement itself.

The yield goes up as the price of the bond goes down, therefore to look at this chart in terms of prices, turn it upside down.

So, onto the comparison. Kwarteng said the government intended to expand the supply side of the economy through tax cuts, targeting growth at a rate of 2.5% a year. The Office for Budget Responsibility has announced that Rachel Reeve’s budget will barely impact growth and that the new expected target for 2025 is 2%, rather than the previous 1.9%, then dropping to 1.5% in 2026 and then in fact dropping below its pre-budget forecast.

Corporation Tax

Kwarteng: The previously planned increase in corporation tax was to be scrapped. It was set to remain at 19% to drive business growth. He said keeping it at 19% would help attract more companies to the UK and encourage investment, eventually reimbursing the government through the taxation of larger profits.

This would ‘plough almost £19 billion back into the economy’, Mr Kwarteng declared that the UK would “have the lowest rate of corporation tax in the G20.”

Reeves: No change to corporation tax which is now, and will remain, at 25%

Income Tax

Kwarteng: The basic rate of income tax will be cut to 19%.

This impacts those who currently pay 20% on annual earnings up to £50,270 (from £12,571). The government estimated that this change would have meant at least £170 a year more for over 30 million Brits.

This would mostly have affected and benefited the average ‘working’ person (positively).

Reeves: From the 2028/2029 financial year, income tax thresholds will be uprated in line with inflation once again, ending a freeze in place since 2022. Other than that, there is to be no change in income tax.

National Insurance

Kwarteng announced that he would reduce National Insurance by 1.25 percentage points, thereby reversing the increase introduced by the then former Chancellor Rishi Sunak to raise more money after COVID.

Reeves announced Wednesday that the main rate of employers’ National Insurance contributions will increase from 13.8% to 15% from April 2025. The rate increase is coupled with a reduction to the threshold at which employer contributions become payable from £9,100 to £5,000,

Contrary to Labour’s pre-election promise, this will impact ‘working people’. Having initially denied it, Reeves has now admitted that workers will be paid less as a result of the increase in national insurance contributions from employers, with experts warning about a prolonged pay downturn. Forecasts show that in 2028, weekly earnings will be just £13 higher than they were in 2008.

Stamp Duty

Kwarteng cut stamp duty in England and Northern Ireland with immediate effect. No stamp duty would be paid on the first £250,000 of a property’s value. That’s double the previous threshold.

Furthermore, the threshold for first-time buyers was increased to £425,000. Government estimates suggested that around 200,000 more people will avoid paying stamp duty altogether as a result of this action. This would have benefited the lower-income earners the most and helped younger buyers.

Chancellor Rachel Reeves announced cutting the threshold back down to £125,000 which will see first-time buyers pay more from next year. A return to previous stamp duty thresholds from April 2025 will result in an additional 20% of first-time buyers being liable to pay stamp duty and a further 14% will be required to pay a partial amount.

Laura Suter, director of personal finance at AJ Bell, comments: “A decision by Labour not to extend temporary cuts to stamp duty rates in the Budget means those buying a new home will pay thousands more in tax from next April. Former Prime Minister Liz Truss introduced cuts to stamp duty for both first-time buyers and home movers, but they expire on 31 March next year and new Chancellor Rachel Reeves has chosen not to extend them.

“A cut to interest rates has only just reignited the property market after a period of sluggish sales, but now Rachel Reeves has thrown cold water on its fortunes with a big tax hike for home movers. First-time buyers will be hit the hardest as they see their tax-free band dramatically reduced. At the same time those buying a more expensive first home will no longer be eligible for the stamp duty break.

Reeves has also increased the stamp duty surcharge on second homes and investment properties from 3% to 5% which became effective on Thursday causing chaos for those who had already agreed purchasing prices.

It’s hard to argue against the concept of extra tax for second homes, but many of these are investments and make more homes available to the rental market. It’s not just those with a second house in the Cotswolds!

Investment Zones

The Chancellor Kwasi Kwarteng revealed that the government was in talks with almost 40 local authorities about the rollout of new ‘investment zones’. This would see taxes slashed for businesses in designated ‘zones’ for 10 years to ‘support investment, jobs and growth’. Measures include cutting planning rules, business rates, and waiving stamp duty.

The Chancellor Rachel Reeves confirmed that the government will continue to support Investment Zones in the UK as part of its economic growth strategy.

Documents published shortly after the speech said funding was available for the Investment Zones and Freeports programmes UK-wide, including approval of the East Midlands Investment Zone to support advanced manufacturing and green industries, and the designation of five new customs sites in existing Freeports.

Bryan Bletso, partner and Head of International at Irwin Mitchell, said: "We welcome the government’s commitment to freeports and investment zones, which are pivotal in enhancing the UK’s appeal to foreign direct investment (FDI). These initiatives not only stimulate economic growth but also create a conducive environment for international businesses to thrive.”

There were other things in the mini-budget such as making regulatory change in order to increase investments by pension funds into UK assets; freezing duty on alcohol; introducing VAT-free shopping’ for overseas visitors – essentially, a number of implementations all with one purpose, to kickstart growth into the UK economy.

It is a shame it never got off the ground. The country was incensed by it. Never have so many people been so angry about something they didn’t understand.

‘The Markets’ crashed is all anyone will remember.

Only the Gilt market should have been adversely affected. This is the market where the government goes to borrow money. Its stability is a global issue, and it’s very very important that it remains steady - as Truss soon found out.

The equity market would have mostly likely done very well once the dust had settled. Cutting National Insurance, cutting corporation tax - these would have been great for local businesses as well as larger corporations. However, It was ultimately impacted by the bond market which was where the real trouble happened and here is why:

You can’t spend £45 billion you don’t have. You can of course say ‘We’re going to borrow it’, and that’s fine, but if you haven’t warned anyone, then investors holding Gilts (the government debt the price of which moves all day every day) would sell – who wouldn’t?

Prices are determined by market makers. These are traders at banks and investment houses who will show a two-way price (Bid and Offer) to the market thus providing liquidity. It’s not a magic place which is perfectly run by governments, it’s run by traders who have one job, to make money.

As a market maker of government bonds in the past, I can speak with some experience. If I was pricing Gilts at the moment the government announced it was going to borrow an extra £72 billion within the next 6 months, do you think I would:

a. remain sensible for the good of the nation and provide a two-way price similar to the one I was making before the announcement or

b. dump every Gilt I had and go short as much as possible. Then lower all my bids and refuse to buy anything. Then sit back and wait for the government to enter the market and sell £72 worth of debt that I was now short.

The answer, that’s right, it’s b, and that’s exactly what happened. Why hold on to an asset when you know for certain you will be able to buy it cheaper at some point over the next few months?

The same thing happened when Gordon Brown announced on 7^th May 1999 that he was going to sell around half the UK’s gold reserves in a series of auctions. This amounted to 395 tonnes of gold which he sold for a total of $3.5 billion, or around £2.7 billion.

If you tell a market, any market, that you are going to sell, the price collapses. 395 tonnes of gold is a lot of gold; in fact, it’s about 13.9 million ounces. When he made the announcement, gold was trading at around $282 per ounce but the advance notice of the sale drove the price of gold down by 10% by the time of the first auction on 6^th July 1999. Gold traders keen to profit of the stupidity of the government’s actions shorted gold and then waited for the UK to enter the market and sell 13 million ounces.

The price reached a low of $252 per ounce on 20^th July. This is now known in the gold market as ‘Brown’s Bottom’.

Since that date, gold has rallied around 1,090% and is today trading near all time highs of  $2,747.

The gold Gordon Brown sold for about $3.5 billion would be worth around $38 billion today. It is one of the worst trades in history and it’s why the government needs to be more savvy about how financial markets work, or they end up getting found out by ‘The Markets’.

Gilt yields are higher today than they were at the start of the week because Rachel Reeves announced that she is going to borrow more money. It’s that simple.

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