The UK government’s mini-Budget unveiled plans to introduce £45bn worth of debt-financed tax cuts, which saw the value of the pound fall to its lowest level against the US dollar in over three decades.
The Bank of England (BoE) now plans further “significant” interest rate rises to prop up the pound and control inflation, representing another hurdle for UK businesses to overcome amid worsening economic conditions.
Making matters worse
Giles Coghlan, chief market analyst at HYCM, a leading multi-regulated broker, pointed out that the huge fiscal package was seen as setting up a “perfect environment” to make inflation worse, drive interest rates higher, weaken consumer spending – and subsequently hit UK businesses hard.
“Most people in the know consider that the only real tool to combat inflation is hiking interest rates,” he says.
“However, higher rates mean higher debt repayments, higher mortgage payments, and that all means less consumer spending power to go around to support businesses.”
The BoE has also now intervened with emergency measures to temporarily buy existing 30-year government debt (gilts) to stabilise bond yields.
Some economists forecast that the BoE’s base rate will rise to nearly 6% by Spring 2023.
“The pound sold off so heavily as the future expectations just got a lot worse in the UK where inflation is being fuelled and made worse by fiscal policy,” says Coghlan.
Craig Erlam, senior market analyst, UK and EMEA at online FX broker OANDA, notes that the International Monetary Func (IMF) commentary on the UK government’s mini-Budget added to the “chorus of scathing attacks on the country’s fiscal plans”.
In a rare reproach by the IMF, it warned against “large and untargeted fiscal packages” and urged the UK government to “re-evaluate” tax measures and provide more targeted energy crisis support in its next budget, scheduled for November 23.
“Moody’s was equally scathing, warning that the measures are a credit negative that could threaten the country’s credibility with investors and more permanently weaken the UK’s debt affordability,” adds Erlam.
“It’s no surprise then to see sterling plummet once more.”
Stan Mlatac, CFO at RedCloud Technology, says that a better balance needs to be struck between curbing inflation and fiscal policy to promote business growth.
“Inflation is likely to remain high beyond 2023, and will probably be combined with a recession, as announced by the [BoE],” says Mlatac. “In this context, the two most worrying questions are: What balance should we aim for between inflation and growth? How to we handle monetary and budgetary action once we have moved away from equilibrium?”
Mlatac also expressed concerns about the possible start of a wage-price loop – whereby rising prices increase demand for higher wages, which in turn leads to higher production costs and applies further upward pressure on prices.
Business investments that lead to productivity gains would be beneficial for both companies and the wider UK economy.
“Investing is a necessity for any CFO wishing to see his business grow, as it is the first way to improve productivity and your position in the market,” he says. “Tax incentives are essential to encourage CFOs to do so.
“For physical assets, it would be desirable to extend and simplify the criteria for granting relief for capital purchases and for the Annual Investment Allowance (AIA).”
Mlatac says he would be particularly attentive to any government proposals for intangible investments.
“In terms of innovation, the modernisation of the R&D tax credit scheme [coming in from April 1, 2023], is favourable to [RedCloud] by extending it to the costs of cloud computing. This reinforces the importance of this technology for the future of our economy,” he says.
“In terms of human resources, RedCloud always needs new talents, whose training must be constantly renewed. I would like to see more tax incentives in this area, supporting the employees to shape their skills around the jobs of tomorrow and the new technologies.”