Why is the UK Budget so Important to investors and the Pound?

The Pound has recently been put under a lot of pressure both from the Bank of England and the UK Budget. This has investors questioning what brought the UK to this point, and what should they expect for 2023?

The prize for the biggest decline in 2022 goes to the Japanese Yen. Though the Pound also has seen one of the strongest declines in 2022. This year, the Pound shot down by 15% which is one of the largest experienced in recent years. The decline was a result of the new budget put in place by Ms Truss. This is a policy which nowadays we call “Trussonomics”, while others simply call it a disaster.

Truss and Kwarteng’s Budget

The UK was the country that struggled most from the G7 with the recent changes seen throughout the economy. This includes double-digit inflation, cost of living, energy bills and slowing economic growth. The Prime Minister put forward an ultra expansionary fiscal policy as the UK was certainly heading towards a recession.

The issue with this is that the country was already struggling with high inflation and it left a huge gap in the country’s growing account deficit. The issue was not just the policy but also the timing. According to economists, if the policy was introduced before Covid-19, the market reaction would most likely have been positive.

The Pound, as well as British GILTS, significantly declined when the budget was put in place. Investors started to sell believing the account deficit would increase the risk of default. As a result, the country lost a big chunk of its wealth due to the currency declining. In addition to this, the cost of the government borrowing through GILTS shot through the roof.

Lastly, the Bank of England’s decision to end Quantitative Easing also put the currency and other UK instruments under further pressure. Though some believe this was done to oust the Prime Minister, whom they did not agree with.

A New UK Budget

Most economists agree a change in leadership was needed. The new government wanted to assure investors they can have confidence in the new budget and the UK’s responsible spending. At the start, the move seemed to work and the Pound recovered as did the FTSE100 and GILTs.

However, the reaction to the new budget has also not been that great. Better than before, but not great. So what has the Chancellor just announced?

Firstly the UK government will increase taxes on the profits of energy companies from 25% to 35% and introduce a temporary tax on electricity producers in the amount of 45%. Also the threshold which the higher band taxpayers are taxed was lowered, according to Mr Hunt. The tax threshold was reduced from 150,000GBP to 125,000GBP.

However, for the Pound, it is not only the budget which will be the deciding factor. According to the Office of Budget Responsibility (OBR), the economy is expected to decline by 1.4% in 2023. In addition to this, the Chancellor also advised that a recession is imminent.

On top of that, the OBR advised that inflation would decline only to 7%, which is still more than 3 times the national target. Economic decline, higher unemployment and high inflation can be a difficult cocktail to stomach. This is why investors will be looking closely at the GDP figures to determine whether they   by 1.4% or more.

In conclusion, we can see that investors have not necessarily reacted negatively to the latest budget. Though the Pound hasn’t seen any signals from indicators gesturing an upward trend either. For sure it looks as though 2023 will be a difficult year for the UK and the GBP.

However, investors should note that the exchange rate would also depend on the counter currency. Specifically the US Dollar which has significantly increased in value over the past week. The Federal Reserve’s Monetary Policy has significantly supported the Dollar over the past 8 months.