A barely-known Prime Minister, a mysterious chancellor – and a plan with the feel of a 1980s fancy dress party.

It’s back to the future in Downing Street for the UK’s third policy reset in a decade.

The UK government’s 2022 Mini Budget cuts taxes and aims to boost growth even as the Bank of England is elsewhere applying the brakes.

Which is not to say that PM (and sometime royal stand-in) Liz Truss and chancellor Kwasi Kwarteng aren’t doing the right thing in cutting taxes now and putting off the bill for later.

Time will tell. But the UK economy was hardly humming under the prior plans, and there’s case for trying something different.

In particular productivity has been in a rut for a decade:

Source: LSE/ONS

Truly woeful, and there’s something for everyone when it comes to allocating the blame.

That LSE paper points to Britain’s exposure to financial services during the 2008-2009 crisis, the follow-up austerity drive, too little investment in infrastructure, and the ongoing drag from Brexit.

A right-wing perspective would foreground the relentless expansion of the State.

Others might blame UK PLC’s reliance on cheap labour rather than investing in technology.

More recently, the pandemic won’t have helped.

Pick your poison. There’s clearly a sickness here.

As for the cure, I’m sure there’s a political dimension to the bottle that PM Truss has reached for. But at least I’m heartened by her claim she’s willing to be unpopular. Her admission – six years after Brexiteers blathered that it would be an easy prize – that no US/UK trade deal is coming anytime soon is a start.

Populism has done great harm in recent years. The spell can’t be broken soon enough if we’re to make the best of where it’s left us.

The 2022 Mini Budget highlights

Which brings us to those tax cuts and reversals and the other just-announced measures.

Here’s a summary of Friday’s Mini Budget from the BBC:

– The basic rate of income tax will be cut by 1p to 19p from April 2023

– The 45p tax rate for top earners over £150,000 will be abolished, also from April next year

– The level at which house-buyers begin to pay stamp duty is doubled from £125,000 to £250,000

– First-time buyers will pay no stamp duty on homes worth £450,000, up from £300,000

– Planned rise on corporation tax from 19% to 25% is scrapped

– A 1.25% rise in National Insurance to be reversed from 6 Novemnber

– Cap on bankers’ bonuses, which limited rewards to twice the salary level, is axed

– Cost of subsidising both domestic and business energy bills will cost £60bn for the next six months

-Strike action: unions will be required to put offers to members during pay talks

– UK to introduce sales tax-free shopping for overseas visitors

Expect more to emerge as journalists and wonks dig into the detail.

Just one example – the controversial IR35 legislation is to be repealed.

The big picture take is the UK government is cutting its income even as its outgoings rise with inflation and the higher cost of servicing debt.

Oh, and the rich have just gotten richer.

Short-term this looks optically bad, but it isn’t entirely mad. You could even argue its conventional counter-cyclical Keynesian economics.

But it will be a tricky balancing act.

Singapore sling

The stated goal is growth. If one was to turn to the toxic B-word, it’s a tentative step towards the Singapore-lite model of a ‘business first’ post-Brexit Britain.

Lower taxes, lighter regulation, and a smaller state (/safety net) traded off for higher growth.

Let’s leave aside whether this is anything like what most disgruntled working class Brexit supporters voted for. Once you add up any small pros and take away the huge cons, I don’t see any economic advantage for Brexit. But in purely economic terms, I’ve long said diverging from the European model towards a more cut-throat US-style capitalism is the closest we’ll get to neutering the economic downsides

Again, it’s not what I voted for. But there is an economic logic to it.

Still I remain skeptical about how far Britain can go in this direction.

We’re not Singapore – demographically, culturally, or geographically. We don’t live in small apartments in a single city with our elderly parents. UK politicians can enable sewage to be dumped in the sea, but the EU won’t allow shoddy goods to be dumped on the continent. We’ll have to meet the standards of our largest trading partner and it will naturally resist regulatory arbitrage on its borders.

As for state spending? We’re getting older and sicker. The National Health Service is the nearest thing the UK has to a religion. And I’d argue the population’s sense that government should solve its problems has only grown under the years of populist magical thinking.

It’s hard for me to see growth coming wide and fast enough to offset the pain from really taking an axe to state spending, if that’s the follow-up punch to come.

There’s an election coming in 2025. We’ll get a verdict then I suppose.

Interest rates could spoil the party

Making life even harder is the macro-economic backdrop that’s (mostly) neither of the government’s making nor under its control.

Inflation is rampant, and Truss has already (rightly) signed up to borrow billions to ease the energy crisis for individuals and businesses.

We are more or less at war with Russia – and if a few hundred billion is the ultimate price of victory (or even a negotiated stalemate) then it’ll be cheap compared to the priciest charges on the menu.

Yet while energy price caps should curb official inflation figures in 2023, still more borrowing piles greater pressure on the UK’s creaking balance sheet. That could be longer-term inflationary.

Already the Bank of England hiked interest rates this week by another 50 basis points, to 2.25%.

That’s the highest level since 2008. But scarier still is this chart (courtesy of Ed Conway from Sky News) showing how expectations for peak rates have soared in just a few months:

The expected peak is up by 2% to 4.75% in just a matter of weeks!

And while that might not sound especially high to old hands, Conway correctly highlights we’re far more indebted than when higher rates last prevailed.

Indeed he calculates that if rates were to hit 6% – outside expectations but again look at the rate of change above – then the mortgage burden would be similar to that which precipitated the property market crash of the early 1990s.

Debt markets are also a downer

We can then see the contours of the economic struggle taking shape.

The Truss government has decided to go for growth, as we used to put it. Today’s tax cuts take tens of billions a year out of the Government coffers and puts it back into our hands.

But the UK State is hugely indebted. And the cost of maintaining that debt is already soaring with rising interest rates.

Indeed the 10-year gilt yield jumped nearly 0.5% higher following Kwarteng’s mini-budget:

Source: MarketWatch

Lower taxes and austerity out the window means less fiscal tightening – perhaps even fiscal easing – exactly when we face huge inflationary pressure.

Which – given the Bank of England’s inflation target – in turn means higher interest rates. And that will strain household balance sheets and even risk a housing crash.

It sets up a push me pull you between the Chancellor and the Bank of England.

Politically this takes some pressure off Truss. Her government will be tax-cutters, leaving more money in people’s pockets. The Bank of England can be the bad guys, taking money back with higher rates.

The hope must be that faster growth will – among other things – reassure the capital markets and keep a lid on borrowing costs.

The risk is it doesn’t.

The pound has dropped nearly 2% this morning as gilt yields have risen.

I wouldn’t say that’s a huge vote of confidence, although to be fair it probably more reflects a ratcheting up of uncertainty.

Giving to Peter to pay Paul

How the push me pull me will resolve itself is anyone’s guess.

A similar-ish Thatcherite direction in the 1980s did deliver a growth spurt. I’d also argue it helped wrench Britain out of secular decline.

But inflation was a fading threat by the time the Thatcher boom really kicked in. We also had the windfall of North Sea oil revenues to paper over the cracks.

Perhaps a better way to conclude is to ask what this means for the typical Monevator reader who is saving hard and aiming for financial independence?

Well, firstly I don’t think it should change anyone’s long-term strategy.

Again, UK governments come along like buses these days. The 2025 General Election could easily shift things again.

But in broad strokes I’d say it’s tactically advantageous for us – but strategically less certain.

From a personal point of view, it’s hard to argue with lower taxes. More money in your pocket means more to save and invest.

I’d also imagine ISAs and SIPPs are safe under Truss and Kwarteng. Perhaps savings allowances – particularly the Lifetime Allowance for Pensions – could even start to rise again.

In the best-case scenario the UK escapes its low productivity trap, GDP grows, and we manage our expanding national debt thanks to higher cashflows from a larger base.

But there’s definitely a downside scenario to this steady accumulation of debt combined with more polarizing economic outcomes. (Plus I don’t see much here for infrastructure).

Careful what you wish for

The UK FIRE ¹ movement is also a kind of two-headed beast.

We benefit from laissez-faire policies in the accumulation phase – especially our favourable tax shelters like ISAs.

But we implicitly lean on state support as we keep taxes low in de-accumulation and – crucially – assume the NHS will be there to take care of our health needs.

Very different from US FIRE-seekers. They can earn and save more but face huge health insurance costs. This may keep them in jobs long after their British brethren would have called it a day.

There’s also the State pension to keep in mind. It’s a huge boon for the typical UK FIRE-ee.

Hence most of us wouldn’t benefit from too-much rolling back of the state and its services. Let alone grimmer potential scenarios that I won’t dwell on today.

Of course there’s not much we can do about it individually – aside from saving more, investing sensibly, paying attention, and hoping for the best.

But what do you guys think? Let us know – focusing on the economics rather than the politics, as much as you can – in the comments below.

1. Financial Independence Retire Early.[↩]

What caught my eye this week.

A few months ago I wrote about stress testing your mortgage ahead of higher interest rates. The threat has hardly abated, with the Financial Times noting that:

Borrowers now looking for another offer as their fixed period comes to an end will face much more expensive terms.

Average rates on a two-year fix have nearly doubled from 2.24 per cent a year ago to 4.24 per cent this week, according to finance website Moneyfacts.

The FT article (search result) adds that banks and building societies have pulled lots of mortgage products off the market, and they are being particularly quick to yank their most competitive mortgage deals.

The best table-topping rates might only be available for a few days before capacity is exhausted.

Hunting high and low

So far, so hairy.

Yet arguably we mortgage holders have never had it so good.

Because what would be spectacularly odd to any time traveler from the 1980s – who oddly chose to gawp at yield curves rather than, say, the iPhone – is the clear blue water between inflation and interest rates.

The UK CPI inflation figure favoured by the government and the ONS dipped unexpectedly this week. But it’s still at 9.9%.

The officially semi-defunct RPI figure that remains widely used in contracts is 12.3%.

Meanwhile the Bank of England’s Bank Rate is only 1.75%!

True, Bank Rate will surely be raised to 2.25% next week – it would already be there were it not for the period of national mourning – and given the state of core inflation I wouldn’t rule out a hike to 2.5%.

The pound falling adds even more pressure to raise rates. Sterling weakness makes imports (and commodities) even dearer – and we import a lot in Britain.

Yet even a 2.5% Bank Rate would be sat 8-10% below inflation, depending on how you measure the latter.

Whereas for most of my life – up until the financial crisis – interest rates ran well above inflation:

Source: Schroders

The Bank of England mandarins are of course familiar with this graph.

But from the start, this current inflationary episode has been seen as more a problem of supply than demand.

And despite a shocker in the US data this week, there are signs the inflationary impulses that set this ball rolling are, well, rolling over.

Inflation is still expected to fall back towards target by 2024. 

The sun always shines on TV

As for demand, does anyone have a sense the UK economy is roaring?

Not me.

Perhaps the housing market has been running a bit hot. But aside from that it would be a watered-down punchbowl that the Bank of England would be taking away were it to get rate-rise happy.

Even an expansionary fiscal plan from the new UK chancellor in his Budget next week would only be giddying-up what seems like a pretty stagnant economy.

It’d probably add a smidge to long-term inflation expectations, because just like last week’s energy relief plan it will likely add to long-term borrowing.

But I don’t see the Budget setting off one of those Tory booms that gets named after the chancellor later when the blame is doled out. (Barber, Lawson…)

An end to conflict in Ukraine would fire up the old animal spirits. But that might equally reduce some of the global price pressures and supply chain issues that were already easing before Putin sent in his tanks.

(Of course I’d take it regardless of its impact on the price of eggs or mortgages).

Take on me

Odd as it seems then, I’d bet five-year fixed rate mortgages will peak at around 4% – at least for this cycle.

Even with inflation running at high teen double-digits for a short while.

In other words, it probably won’t get much worse from here, from a borrower’s point of view.

Of course your guess is (almost…) as good as mine. Events can do a number on economic expectations, anytime, anywhere.

What’s more the Bank of England’s commendably honest and downbeat talk has not been matched by as aggressive a campaign of rate rises as we’ve seen from some of its peers. Maybe the rate-setters will lose their nerve?

Time will tell, but for now inflation is fast paying off your mortgage in real terms.

Enjoy it while it lasts!

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What caught my eye this week.

Time is something you can never have enough of when you’re compounding your way to financial freedom.

That’s because the big payoff from compound interest is back loaded.

In the early years, how much you can save from your income matters most.

But later on, your gains on money already socked away is usually what makes the biggest difference.

A return of say 10% on a near-retirement pot of £1,000,000 is an awful lot more than 10% on your first year’s savings of £5,000.

It’s £100,000 versus £500, to be precise about it.

Clearly the longer you can compound your money for, the better.

Unfortunately we can’t go back in time to begin earlier – the age-old lament of savers when compound interest first ‘clicks’ for them.

But in a novel post at On Dollars and Data, Nick Maggiulli suggests finding a few extra years further down the line as a way of boosting your returns:

How exactly?

According to the data, the answer is…exercise.

Exercising regularly to improve your strength and your cardiovascular health is the most effective way to increase how much time left you have on this Earth, all else equal.

I agree that personal fitness is an under-appreciated part of the game we’re all playing.

Few people would be happy to retire to fewer years than they might have enjoyed if they’d stayed in shape, or with not being able to do as much as they’d like due to physical limitations.

Not if they can help it, anyway. And Nick does his usual great job of marshaling the numbers to show that many of us can indeed help ourselves.

A solid exercise habit can be expected to add three to five years to your life, he finds.

Good, but even better getting fits means an additional six to eight years of your later years might be healthy – compared to if you’d done nothing.

Nick says:

You don’t need stress yourself out trying to save every penny. Instead, you exercise more, reduce your stress, and extend your life. This is a non-financial solution to a financial problem.

And while it might seem unorthodox, for those that are having trouble saving more, it might be the best option available.

Check out the full post, and then get moving!

Have a great weekend.

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