HAMISH MCRAE: If Government can persuade global finance that budget will revitalise economy, it has chance of better outcome than Black Wednesday
Emergency budget: Kwasi Kwarteng
The eyes of the world will be on the UK this week, but after tomorrow the focus will shift from the spectacle of splendour and sadness to the harsh reality of how its new Government will seek to rebuild the nation’s economy and its finances.
Viewed from this side of the Atlantic, the backcloth to Kwasi Kwarteng’s emergency budget next Friday looks pretty bleak.
The dollar is riding high as the safe haven in troubled times, and the pound – well, it has taken a real beating, down below the level it was against the dollar when it was kicked out of the European Monetary System on Black Wednesday 30 years ago.
That made George Soros a fortune, destroyed the reputation of John Major’s government, and paved the way for New Labour in 1997. It is an uncomfortable memory and the stakes now are high.
There will be the immediate political judgment in Britain but in some ways the financial and economic judgment of the rest of the world will matter more. If this Government can persuade global finance that this budget will revitalise the economy, then it has a chance of a happier outcome than the one that followed Black Wednesday. And for global finance, read the US, for that is where the money resides. So what will big money look for?
Well, the first thing to say is that the fate of sterling does not occupy much space of mind in America. What matters is the next decision of the Federal Reserve – might it increase rates by a full point, not just 0.75 per cent? – whether the bottom of the bear market in equities is in sight, the prospect of a global recession and so on.
UK assets are a niche market with some interesting possibilities, but one that remains out of fashion. Fashion flips, but before that can happen there has to be a general rebuilding of confidence, and that is the challenge the new Chancellor faces. We don’t know the detail of course, but we know enough of the thrust of his proposed policies to see the points of the challenge.
Challenge one will be to persuade global investors that the increase in the fiscal deficit will be temporary. They will only be prepared to finance it at acceptable cost if they can see a pathway back to a deficit of, say, 2 per cent of GDP.
There is no ideological opposition to tax cuts – how could there be in America? In any case what seems to be proposed is mainly not to bring in the tax increases planned by Rishi Sunak, the rise in National Insurance contributions and in corporation tax. But there has to be a medium-term plan to make the numbers add up.
Challenge two will be to put enough flesh on the bones of this idea for a Big Bang Two to encourage US finance to invest more in the UK. I find the branding of a second Big Bang a bit silly. The original restructuring of the City’s securities markets in 1986 took place because London was operating a different regime from the US – separating jobbers and brokers, not allowing foreign investment in Stock Exchange firms and so on – and that way of running things had become unsustainable.
There are some changes to regulation that can be made now that the UK is no longer a member of the EU, but these are tiny by comparison. Take this business about there no longer being a cap on bankers’ bonuses. What actually happened was that the banks had to increase the base salaries of their stars to compensate for the cap – from their perspective a nuisance but not a game changer. One change that may be helpful is the idea that the regulatory authorities should pay more attention to the City’s international competitiveness.
Promoting London’s financial services used to be part of the Bank of England’s informal mandate when it was the main regulatory body. It worked hard at it, notably choreographing the reorganisation after Big Bang. That role dropped out, so what is happening is a return to past practice.
Challenge three, and I think the make-or-break element of it all, will be whether the Government can significantly increase the underlying capacity for growth to 2.5 per cent. That ought to be attainable.
But the world of finance is a cynical place and will not be impressed by politicians setting growth targets. If there is a serious effort to reduce or eliminate the blockages to growth that have been imposed, often by governments, then the global markets will be impressed. If it is just bombast, they won’t. It is, in so many ways, a big week ahead.