September 29, 2025 • 44 mins
Roger Lee, head of equity strategy at Cavendish, joins Merryn Somerset Webb to explain why he thinks the UK’s worsening public finances could morph from “slowly, then suddenly” into a fiscal event, and what that means for the Labour government, Britain’s international standing and investors.
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Speaker 1 (00:02):
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:17):
Welcome to Meren Talks Money, the podcast and its people
who know the markets to explain the markets. I am Meren,
Somerset Web. We are recording this episode on September twenty fourth.
Now this week I am speaking with Roger Lee. Roger
is currently head of equity Strategy at UK based investment
bank Cavendish. He's been in the equi market for a
long time, nearly thirty years, spending time at HSBC, Deutsche
(00:38):
Bank and JP Morgan. Most recently he was head of
the UK equity strategy at Investork. He's got a lot
of experience here. He's covered UK equities, European equities, US
equities and of course crucially he's also a fellow of
the Institute of Chartered Accountants, a physics graduate, and a
frustrated politician. How's that for an intro. Roger, thank you
(00:59):
so much for joining us today. I think we might
all be frustrated politicians.
Speaker 3 (01:04):
Oh thanks, thanks very much for that wonderful introduction. In
factor frustrated politician in fact, the least successful politician ever
because I tried to get selected twice and failed both times,
dismally frustrated, but not so frustrated now I have to say.
Speaker 2 (01:19):
Yeah, no one wants to be a politician right now,
and that is exactly what we're going to talk about.
And one of the reasons that I asked you on
Roger Bisk is I've read some of the things that
you've written about the fiscal situation of the UK and
just how bad it is and whether there is a
possibility that it is so bad that it genuinely does
cause a fiscal crisis and possibly the downfall of this
government in the UK. So it seems an extraordinary thing
(01:40):
to say, given that this is a government with a
huge majority. We look at them and you think, well,
surely they'll go a full term. But actually, of course,
as my colleague John Steppeck always says, we must try
to think of this less as a majority government than
a coalition government because of all the different viewpoints inside
the tent, and with that in mind, and the fiscal
position in things may be a little bit more tenuous
(02:01):
than perhaps our Prime minister would like to think. So
why don't we start by looking at the fiscal position
in the UK and just run us through quite how
bad this is.
Speaker 3 (02:13):
Let's just step back for a second and just think
what a fiscal event is.
Speaker 1 (02:17):
Now.
Speaker 3 (02:18):
Most of us have lived through a fiscal event, which
was clearly Lisztrust back in twenty twenty two, and a
fiscal event is usually considered something when the guilt market
gets very concerned and guilt yields rise very rapidly. In
that particular instance, guilt yields went up one hundred basis
points or one percent in a four day period and
(02:40):
there had to be some sort of intervention from the
Bank of England. And clearly European sovereign debt crisis was
a series of fiscal events. They are uncommon, but they
do happen, and it's usually characterized by government debt yields
going out very rapidly, So that is a fiscal event. Now,
again for background, there have been since this government came
(03:01):
into power, there have been three mini fiscal events where
guilt fields have gone up twenty basis pointser point two percent,
so not anywhere near the one hundred basis points that
you would cause some problems, but they have moved very quickly,
in some cases in a matter of hours. And the
three occasions were immediately after the October budget last year
when the market got very concerned about growth outlook and
(03:24):
increased issuance. In January when guilt yields went up partly
because US treasury yields were going up, but also concerns
about growth. And then of course during Rachel Reeves, our
Chancellor's difficult day in the Commons, when gilt yilds went
up twenty basis points in a matter of minutes. We
(03:44):
have had three occasions when there has been some sort
of stress in the guilt market in this administration. And
what I think we're going to talk about now is
what would prompt that to be significantly worse than just
a zero point twenty basis point move. Okay, And so
(04:07):
what I think prompted this and what is I think
has prompted a lot of people's interest in what might
happen is really following on from the public sector net
borrowing numbers now to older listeners, that is used to
be called the public sector borrowing requirement. So if I
do mix the two up, they are essentially the same.
So the public sector net borrowing requirement is really the
(04:29):
funding requirement that the government has, or at least in
this particular instance, it's obviously a deficit is that the
government is spending more than they are receiving in tax revenues,
and the OBR and the ONS publish this data every month. Now,
in August, which was the data that was published last Friday,
it was clear that the government is spending a lot
(04:51):
more than they're generating in tax revenue. In fact, I'm
not going to burden you with too many numbers, but
I'll just give you some sort of context here. In August,
the government had to borrow or the deficit between spending
and tax revenue was eighteen billion pounds. Now, that compared
to an OBR forecast for the month of just under
(05:12):
thirteen billion pounds, so forty percent overshoot. Now, that in
itself is not necessarily a problem. What is a problem
is that for the first five months of the year,
spending has overshot tax revenue by sixteen billion. That's for
(05:33):
five months. Now, this isn't particularly complicated, so just bear
with me. But if the government has overspent by sixteen
billion in five months, that's just over three billion a month.
If that run rate continues for the year, then that's
clearly thirty six or thirty eight billion rounding up, So
let's call that forty billion of overspend for the year. Now,
(05:59):
that again isn't necessarily a problem, except compared to what
the OBR are forecasting for the debt for this year.
So the OBR are forecasting that debt levels actually start
to come down, or the rate of the deficit slows
towards the end of the year. There's always this kind
(06:21):
of seasonal effect in this as well, because we are
payout taxes in January, so borrowing does come down seasonally.
But they're expecting debt to come down significantly from last year. Again,
I'm sorry to give you some numbers, but I can't
text it. I'm threatened. So last year the government borrowed
about one hundred and fifty billion. That was the deficit
(06:42):
last year, one hundred and fifty billion pounds, and this
year the OBR are forecasting the deficit to be around
one hundred and twenty billion pounds, so clearly less.
Speaker 2 (06:53):
Than Okay, hang on, to take me back a bit,
how does that connect to the forty billion we were
just talking about. I thought you said it was going
to be around forty billion by the end of the year.
Speaker 3 (07:00):
So we're currently overspending by forty billion if we annualize
the current overspend. But the OBR is expecting debt to
be lower this year than the.
Speaker 2 (07:14):
Last year, so they're expecting it to turn into an
underspend over the next seven months.
Speaker 3 (07:18):
Yes, or they're expecting the revenues to pick up and
spending to slow. Absolutely. So the question I think people
are beginning to ask themselves is what if spending doesn't slow,
What if tax revenues don't increase. What happens if we
(07:39):
carry on spending at the same rate as we did
last year. Now, if that is the case, then last
year we spent or overspent by one hundred and fifty pounds,
So if we have the same outturners last year, that
is still more the and the OBR are forecasting. But
(08:03):
as we stand today, we're spending all the deficit is
higher than it was last year. So there are two
issues here. One why will the deficit come down in
the second half of this year? And secondly, if it
doesn't come down and the deficit run rate continues as
(08:26):
it is in the first five months of the year,
then the conclusion is that the deficit will be one
hundred and fifty billion if it was the same as
last year, but including the overspend or the increased deficit,
increased run rate, however you want to describe it, that
is an additional forty billion pounds.
Speaker 2 (08:47):
Okay, now we get to that turn.
Speaker 3 (08:49):
So the outturn could an ice stress could be closer
to one hundred and ninety billion of deficit, not one
hundred and twenty that the OBR are forecasting. So that
is the kind of the punchline here, And it is
(09:11):
not just me doing the numbers. And as I say,
this is just purely arithmetic. It's not a forecast, it's
not our house view, it's not a central case. It
is just merely extrapolating the arithmetic that we've seen over
the last five months and making a not unreasonable assumption
(09:32):
that the deficit this year is going to be closer
to the deficit that we saw last year, and then
adding that overshoot onto us.
Speaker 2 (09:40):
Okay, let's carry on with this terrifying conversation by talking
about what it is that the OBR expects to bring
tax revenues up and spending down over this year and
the extent, which is that may or may not happen.
Are they expecting an increase in tax revenues for example.
Speaker 3 (09:57):
So there are essent three areas where the OBR are
forecasting that tax or forecasting both tax will be higher
and spending will be lower. And we can discuss the
likelihood of whether this will actually come to pass. But
the three areas that they're talking about is that capital
receipts capital tax receipts will be higher in this fiscal
(10:19):
year than last year. Now most economists think that might
be the case. There is a possibility that could be the.
Speaker 2 (10:27):
Case, and that would be the case. Sorry, just to interrupt,
that would be the case. Why because the rate has
gone up, and because with markets doing very well, etc.
And more people will be making capital gains because people
are beginning to sell, for example, by to let properties
they've held for quite a long time, and there'll be
a rade of capital gains coming from those. So all
these things combined, I think.
Speaker 3 (10:46):
That's the general argument. Yes, yeah, thank you. The second
area where the OBR think that the deficit will start
to fall is because lower debt interest, that is, the
debt interest that the government have to pay to issue
new guilts into the market. Now that the OBER, again
(11:08):
broadly speaking, forecast tenure treasury yield are ten year guilt
yields to be four and a half percent. Guilt yields
are already higher than that today.
Speaker 2 (11:18):
What are they today at four point seven.
Speaker 3 (11:23):
And obviously thirty year guiltields are even higher at close
to five and a half percent. So it is very
difficult to see how lower funding costs are going.
Speaker 2 (11:36):
To help.
Speaker 3 (11:39):
This deficit issue. In fact, if anything, it will be
the reverse. And the third area that the ober are
still believing the world reduced the deficit, and this is
a spent on the spending line again, is that they're
expecting lower growth in welfare spending. Again, it's difficult to
(12:00):
see how that is going to be the case, given
that the welfare cuts that had been proposed clearly were
rejected by the Labor Party back in July. So it's
difficult to see why this deficit is going to come
down in the second half.
Speaker 1 (12:20):
Now.
Speaker 3 (12:21):
What is perhaps easier to see is if the economy
continues to slow as it's doing at the moment, and
if the labor market continues to deteriorate, and we source
some disappointing survey data earlier on in the week, If
the employment market continues to slow, then growth will slow
(12:42):
and therefore tax revenue will slow. So the income side
of this might slow because of slowing growth, and the
expenditure side might rise because of increased welfare payments in
order to support those who are no longer in work.
I've already seen an element of this in last Friday,
(13:03):
which again I think is why last Friday's PSNB numbers
were so interesting is we've already seen an element of
this because one of the reasons that the Ober said
for this overshoot in the deficit or overshoot in the
borrowing requirement was because of lower VAT receipts. Now, lower
VAT receipts are directly linked to demand, they're directly linked
(13:28):
to growth, and they're directly linked to consumer confidence. And
so what we're already seeing is that lower demand feeding
through into lower purchases, lower basket sizes, and that is
feeding directly through into lower VAT receipts. And AVIAT is
one of the largest tax generators in the UK. Now, again,
(13:51):
this is not a huge surprise, Lord Wolfson in his
next report, which I think you referred to recently in one.
Speaker 2 (13:59):
Of you and I talked about it in one of
our market round ups, because those reports are always incredibly insightful,
so it was not something I wanted to read.
Speaker 3 (14:08):
He's so good, hugely, hugely insightful, And I think you
cited the fall in vacancy rates and the issues that
the lack of vacancies that next now have and the
number of applicants that they have going up. What he
also obviously cited right at the front of the report
in his outlook statement was that he's concerned about slower
(14:29):
consumer spending now that is already directly seen by the
OBR in those lower V eight receipts. So again it's
not a question of being sort of sensation list in
any way. It is just know. What the ABR said
on Friday was that net debt or debt had exceeded
(14:53):
expectations by some forty percent, and the reason for that
there was also elements of local authority thing, which is
quite technical and has a habit of reversing anyway. But
also but what was very tangible was lower V eight receipts. Now,
I'm not sure anyone out there is forecasting a huge
search in growth for the remainder of this year. In fact,
(15:15):
I would suggest that most people that are forecasting the reverse.
Most economies are forecasting the reverse.
Speaker 2 (15:20):
So sorry, carry on.
Speaker 3 (15:25):
I was I was always just going to conclude that
if anything, the risks to given the risk to the economy,
the risk therefore would would suggest that the actually tax
revenue will be less than the A B R are forecasting,
and also even less than last year, and the risk
(15:47):
that wilfire spending will be higher.
Speaker 2 (16:05):
So for this to turn around, for the math to
pan out differently, we either need a sudden, very unexpected
surgeon growth, a sudden, also very unexpected massive decline in
our spending, particularly on welfare, which is the obvious area study,
or a sudden collapse in interest rates in guilt rates,
and none of those things seem very likely right now.
Speaker 3 (16:25):
Yeah, well, that's an interesting one. Absolutely, to an extent.
Government finances are very straightforward. They are very similar to
our own personal finances. They have income from tax revenue,
they have expenditure, which is what their spending programs are,
and if there is a gap between the two of
them a short for then they have to borrow. That
is no different to any of us in terms of
(16:46):
how we fund our data day expenditure. Now, instead of
going to a bank. Clearly they do. They go to
the Bank of England and or the Debt Management Office
and they issue guilt. Now, one of the reasons why
this is bound perhaps more relevant now and certainly why
we have started talking about it a bit more. I
stress again that this isn't necessarily a forecast. One of
(17:09):
the reasons we have talked about a bit more is
because our view was is that interest rates were going
to fall quite sharply towards the end of the year.
So our view was slowing economy as a result of
the corporate changing behavior as a result of the last
budget and the National Living Wage would result in a
slowing economy, which is what we're seeing. There would be
a response in the labor market, which is what we
(17:30):
are seeing, and therefore the Bank of England would cut raids. Now,
the Bank of England are clearly not going to cut
rates because inflation is still very elevated in the UK
three point eight percent, and arguably a lot of that
is to do with the pass through of the National
Living Wage and the national insurance contributions, particularly in the
(17:51):
food sector and energy prices related to net zero, which
again I think you've discussed at some detail in a
recent PODCAG so I won't go down at and not
going to add anything to that, suffice it to say
so it locks in the market, certainly not expecting any
interst rate cuts anytime soon. In fact, maybe only one
more this year. Now that's very different to the forecast
that we would have had two or three months ago. Yeah,
(18:13):
that's so, that makes a big difference, and that is
what has changed. What has changed is that we would
have thought that the Bank of eng That were going
to be able to cut rates quite aggressively. There is
a fairly strong correlation between falling into strates and improving
growth that would have stimulated the economy, and that perhaps
would have been the surprise that you were just talking about.
(18:35):
That perhaps would have been the surprise that you would
have seen in terms of both the growth and therefore
the tax take and obviously reduced wealthare spending and more important,
perhaps reduced and clearly that would have had an impact
on guilt yields now in terms of where the curve
would have gone, and that would have reduced the funding
cost it. So, if you wanted to really pin down
(18:57):
what has changed, two things changed. One is that the
interest rate cuts aren't likely, and we would certainly agree
with that as well in the short term. And secondly,
what's changed is the current spending dynamic is a lot
worse and tax take dynamic is a lot worse than
(19:18):
we were expecting. And it's those two stroke three factors
that have changed.
Speaker 2 (19:22):
Yeah, and the marketer has definitely noticed this. I've talked
about this a lot on the podcast. But the fact
that debt costs in the UK are at the moment
they are still higher than any other G seven economy.
So even though our debt situation on the face of
it is not necessarily worse than some other developed economies,
we're still paying we're paying more for our debt than others.
Speaker 3 (19:41):
Irrefutable on a thirty year basis. In the ustrum some
structural issues around the thirty year bond yielding, thirty year
guilt yields. Now just give some context for this. Compared
to the G seven for the thirty year bond yield,
it's just around to five and a half percent. The
US thirty year, which is the next highest, is four
point seven percent.
Speaker 2 (20:01):
Yeah, it's a big difference.
Speaker 3 (20:02):
It's a very significant difference. Now there are I stress
some structural reasons why that may be the case, but
nonetheless it is quite clear that the global capital markets,
which is where we get most about funding from, because
up until now, relatively few people in the UK own
guilts that we tend to save through bank deposits rather
(20:23):
than buying guilts that is a compare and contrast with
other countries, So we are very reliant on the international
markets in order to fund this deficit, in order to
fund our borrowing, and so therefore we are also very
prone to how international bondhields move. But as things stand
at the moment, the markets are clearly demanding a premium
for a number of reasons, possibly this risk that we're
(20:45):
talking about, and is partly that.
Speaker 2 (20:48):
Okay, So the question then that brings us to the
crunch of the whole thing is how long before things
get worse? And as we know, we've been talking on
this podcast and various other places where John and I
have written and spoken for years about the massive build
up of debt across the developed world and how uncomfortable
it is not just here but elsewhere. And we know
you learn from how long you talk about it, that
(21:09):
these imbalances can build up and up and not be
a problem, and not be a problem, and not be
a problem. Everything's fine, and it goes on for much
longer than you could possibly imagine, and then suddenly it turns.
And when it turns, it also turns much much faster
than you could conceivably imagined before it actually happened. That's
how we get We give, we become complacent, and then kubum,
(21:29):
everything goes horribly wrong. And in a situation like this,
you get to the point where the market says, well,
we'll hang on. It's costing you so much just to
serve at the stet you're in a big part of trouble.
And so what happens next? How do we get to
this point?
Speaker 3 (21:43):
Okay, well, there's a great quote, and I hope you
haven't used this too recently, but there's a great quote
that in economics, things happen slower than you would have thought,
and then faster than you thought they could Exactly, I
think is just so true. But what happens next? Now, again,
just for the benefit of your life, listeners, is now.
Speaker 2 (22:01):
A forecast not a forecast.
Speaker 3 (22:04):
We're now just describing a possible scenario of what happens next.
Maybe you will indulge me in this flight of fantasy,
and I'll leave you to judge how real or not
this may be. Now again, I have to give some
credit here to Andrew's sentence and some of his great
ex posts are on this, and he seems to think
(22:27):
that this event could happen in Q three or Q
four this year, and I'm going to just briefly talk
about why that could be the case. So it comes
back to this public sector net borrowing number that comes
out every month. Now, if the debt profile of the UK,
or the deficit profile of the UK continues on its
(22:50):
current trajectory, as we talked about in some detail a
few minutes ago, and it doesn't come down as we
were suggesting, then each month we will get an overshoot
to what the auber are forecasting. At some point, the
market may extrapolate that through using the arithmetic that we
have very simplistically done just a few minutes ago, and
(23:14):
they may come to the same conclusion that if the
run rate continues and the debt profile this year, deficit
profile this year is the same as in twenty twenty
four or five, and therefore we have a one hundred
and ninety billion, or as android sentence described, one hundred
and eighty five, so pretty close to our arithmetic. Now,
(23:35):
that is a very big number. Again, I'm going to
throw your listeners another number here. The total size of
the UK economy is around two point seven trillion pounds,
so two hundred billion of deficit is around seven percent
of GDP. Wow, I mean that is a huge number. Huge.
(24:00):
So of course, just to reference that, the ECB in
as part of the euro criteria in system around a
three percent deficit, and that would normally be what a
normal economy should run at. These are just huge numbers. Now,
if the guilt market remotely felt that the UK deficit
(24:24):
was anywhere close to that number and therefore had to
be funded by increased issuance, given that the last three
occasions when there was a threat of increased issuance, the
guilt market moved by twenty basis points point two percent. Suddenly,
confronted with one of the worst deficits in the Western
(24:45):
world and a funding requirement of something like eighty billion
or seventy billion more than the OBR are forecasting more issuance,
therefore price must ad just to that increase supply and
guilt yields. The price of guilt will fall and the
(25:06):
yields will rise, and this is how you get into
this potential guilt yield spiral. So guilt yield start to
rise in order to compensate the guilt holders for obviously
more issuance is a simple supply demand dynamic, and at
this point, then guilt yield start to rise. Now the
(25:28):
problem you get, and there were some very specific instances
around us, but what you then get is the cost
of funding goes up as guilt yields go up. We
talked about that briefly. It's one of the big swing
factors in the government's p and L and finances. So
(25:48):
guilt it'd start to rise, that increases the funding costs,
That therefore increases the deficit, which means more issuance, So
therefore guiltields go up again. This is when you get
into the crisis of more issuance, higher yields, more issuance. Repeat.
It's a vicious spiral and we've seen evidence of this
(26:11):
around the world many times. And that then is the
problem that the government will have to deal with. What
you would expect to happen, and this is getting to
the rub of this discussion, you would then expect the
Bank of England to wintercede. Now, the primary duty of
the Bank of England is a financial stability yields moving
(26:35):
very rapidly. Again, we can remember what out in trust
mortgages get withdrawn, financial markets start to suffer significant stress.
Speaker 2 (27:00):
Number would you put on guilt yields for it to
hit the kind of level of crisis at the Bank
of England would intervene.
Speaker 3 (27:06):
Oh, it's about one hundred basis points would probably be
sufficient to cause this. And that's not based on sort
of any scientific measure. It is merely observational of what
happened during the trust what happened guilt yelds body yields
in the periphery during the period of the European sovereign
det crisis went up a lot more than that. I mean,
(27:28):
you do treasure olds getting to four point nine percent
in January, as I said this morning, the four points
around four point seven. They got about four point nine
percent in January, and that was beginning to raise alarm bells.
If they went to five point seven, then I think
you have a problem, okay, And I think most people
would think you would have a problem. At that point
(27:49):
that would be thirty year guilt yields at six and
a half percent. These are big numbers and so at
this point in this scenario, the Bank of England would
be required or as part of its mandate, to ensure
financial stability in the UK, and therefore would have to intercede.
And the intervention would be again similar to what we
(28:11):
saw with Trust, and that is that they would start
some sort of Q program. They would start backstopping the
guilt market. They would start buying guilt so that completely
reverse their QT and have to start buying again. And
they have the capacity to buy and do whatever it
takes to use those words in order to stabilize the
guilt market. The question comes at what price they would
(28:35):
expect the government to pay for that? And I don't
mean a financial price necessarily, but what financial discipline will
they impose on the government. And again this is purely
hypothetical fantasy, but it is difficult to imagine that the
Bank of England would be happy to backstop a situation
(28:55):
like this unless there was a significant can display a
fiscal restraint by the government, and I don't think that
is unreasonable. The risks of not forcing fiscal restraint on
the government would jeopardize the reputation of the Bank of
England as a fiscal constodient of our finances and.
Speaker 2 (29:17):
Such as it is, such as it is.
Speaker 3 (29:20):
And I you not your words, not mine, and I
think that I think given their sort of recent track record,
I think the last thing that the Bank of England
would want to be accused of is fiscal irresponsibility. Would
what normally happens here and again what we've seen in
the periphery is that the Bank of England will insist
(29:41):
on fiscal restraint and fiscal responsibility. So, just going back
to those numbers I just talked about a two hundred
billion deficit. Huge is a seven percent fiscal deficit for
the UK. You could easily see the Bank of England
insisting that behalved, and they would insist on that as
part of this backstopping of the UK guild market.
Speaker 2 (30:05):
You get to the point where that.
Speaker 3 (30:07):
That is now getting into sorry, and that is now
getting very painful for any sitting government. Again, just to
give you the numbers, so that would be around deficit
at that point, let's say keep the numbers very simple,
be around two hundred billion and the banking will probably
potentially insist on that deficit being halved two hundred billion
(30:28):
through some sort of emergency budget.
Speaker 2 (30:32):
And this then, because where you run decision Okay, so
then we go from maths to politics. So you get
to the point where the government has to take an
emergency budget to Parliament and ask its MPs that very
large majority to sign off on one hundred billion quidsworth
of cuts, a large amount of which would presumably because
(30:53):
it's got to be quick, probably full on welfare I'm
guzzing here, plus probably a sharp rise in an immediate
rise in income tax to cover quite a lot of it.
And you're going to ask people who've promised in their
manifesto not to raise income tax and to as a
party prefer to increase rather than degrees welfare spending. And
(31:14):
then suddenly you get a budget that doesn't pass and
you have a proper all crisis.
Speaker 3 (31:19):
Yes, that's that is very succingly port I think that
is the issue. And again we can put some numbers
about that and some sort of recent precedence to it
saving one hundred billion pounds very quickly. That's the sort
of austerity level that Osborne and Cameron did a post
(31:40):
financial crisis in terms of over over several year period
to get that into some sort of one hundred billion
into some sort of context. As well, a penny on
income tax raises about ten billion pounds, So you know,
as you said tax risers, you could easily see a
basic great of income tax going up several pence to this,
(32:01):
and then you've got to address the welfare side of
the equation. So let's say half of this was paid
for by tax risers and the other half paid by
spending cuts. That's fifty billion pounds worth of spending cuts.
On one level, we spend about one point three trillion
in the UK, so that is clearly less than a
(32:22):
five percent cut. But politically, as you will recall from July,
the government we're unable to get five billion pounds worth
of spending cuts through, and we're now talking a figure
hypothetically of ten times that amount. This would be very challenging.
I would have thought for the parliamentary Labor Party to
(32:45):
vote through very challenging. And it's this scenario that then
leads to an interesting constitutional question. Clearly I'm not remotely
pretending to be a constitutional expert, but if a government
is unable to pass this emergency budget because they're sitting
(33:06):
MPs refuse to do it, and this actually may be
an unintended problem of having such a large majority. If
they are unable to pass this budget, then convention suggests
that at that point the government have to dissolve parliament
and go to the country and have a general election.
(33:29):
It's only happened once in the UK in nineteen oh nine,
as it happens, but so we do have to go
back quite a long time. I wasn't even in the
market then and it has only happened once, but it's
happened on a number of occasions in parliamentary systems that
have a similar structure to Westminster. So being unable being
unable to pass a budget is clearly fundamental to how
(33:51):
you govern a country. And so if they are unable
to pass a budget, then one would expect at that
point a general election to be called and enters into
a whole realm of other topics.
Speaker 2 (34:03):
Yeah, that would take us test straight onto what happens
after that, which might be outside the scope of our
imagination of Nigel Farah just talking about or thinking about
expecting an election, and maybe twenty twenty seven. Maybe he
might get his wish, and that would all be rather interesting.
I mean, the key point being that you've run us
through maths as opposed to politics. You've run us through
(34:23):
what could happen given the numbers, as opposed to what
anybody might want to happen. But nonetheless, it does feel
that we are getting to this point where very slowly
and then very quickly, and at some point either something
massive has to change or we do need a crisis
that forces that change. So there's a growing sense of
inevitability of running at the edge of the cliff, isn't there.
Speaker 3 (34:43):
Yes, I don't think. No one's pretending that the fiscal
situation in the UK is anything other than challenging. That
is not a remotely contentious point to make, I don't think.
And also I am not sure. And again I'm not
sure this is a particularly contentious point either, that this
(35:03):
situation of ever increasing taxes at the same time as
ever increasing welfare spending without any growth is probably unsustainable.
Speaker 2 (35:15):
Well, it does get very difficult when you have no growth,
because when there is no growth in an economy, you
are constantly shifting the pieces of pie around between people,
right and that is obviously going to cause conflict for us.
When you have growth, there's more pie to share, so
you don't get quite the same level of well anger
as you do when there is no growth. The lack
of growth is in itself a thing that creates conflict, right, Oh.
Speaker 3 (35:36):
Yes, it is. The lack of growth is the problem.
The government are absolutely right to focus on growth, as
was list trus. It's a question of how you achieve growth.
But growth answers all of these problems. The problem is
at the moment, we don't have any.
Speaker 2 (35:52):
Okay, now let's move on from this. Potentially you call
it a it's not a zero risk event. It's slightly
quite a lot more than zero at this point. But
let's say that this is out there as a possibility.
If this happens, if we end up in this kind
of scenario, and again, so many moving parts, None of
this can be sure. These are, as you said, not forecasts,
(36:14):
simply as suggestions of possibilities. But if we do get
this situation, when we have both a fiscal crisis and
a constitutional crisis concurrently, what happens to markets, all that
nice growth we've seen in the UK equitity market, It
just leaves us in a wanner. What happens.
Speaker 3 (36:30):
That's probably the easiest question to answer that you will
post me all day. They will go down. They will
go down a lot. So let's just that's actually a
bit of a facile answer, because some bits of the
market will go up a lot and some bits of
the market will go down an awful lot, and that's
what we see. So let me just answer that, give
(36:51):
me some give you your listeners a couple of ideas
here and what happens if we know what happened in
the two hours after Rachel Reeves's difficult day in Parliament,
we don't obviously know what happened in the market then.
And what happened was that the metals and mining sector,
which obviously is international learners and it has gold within
(37:15):
that and it has copper. That sector went up. I
can give you the exact numbers. That sector went up
four percent over that two hour period. The UK real
estate sector and the UK house building sector went down
six So in two hours there was a ten percent spread.
These are big numbers. And we also saw you can
(37:38):
go back to trust and see what happened there is
that generally speaking, the two point fifty, The forty two
to fifty, which is very much more domestically exposed, went
down a lot, and the forts one hundred, which is
obviously more internationally exposed, went down, but not as much
because of clearly it has dominated by companies that have
(38:01):
international earnings. Now that's not a complete defense in this
environment because obviously it's the UK that the market is
very concerned about at this point, and so even those
international earners tend to fall, but just not as much
as the domestic place. So we see the market moves.
You know, these market moves are very pronounced, they are
(38:23):
quite dramatic, and they are also quite extreme. But before
that sounds all too frightening, there's also another aspect of
this that is often ignored is that market crises do pass, yes,
and they do pass. The tools are there. They may
(38:44):
be painful for the current administration to administer, but someone
will have to administer them, and that then creates a
very interesting opportunity going forward, just as during trust created
a very interesting opportunity for those who are able to
or nimble enough and have the courage to buy through
(39:04):
the crisis. The opportunities that result from this can be
quite profound.
Speaker 2 (39:09):
So it's worth holding It's worth holding a little cash,
a little more cash than you might have otherwise, next
to your gold obviously, and the emeralds you're going to
put in a hem of your skirts.
Speaker 3 (39:20):
Yes, not to give financial advice, but the writing having
a bit of cash at the moment is certainly could be.
If one is concerned about the outcome of this outcome,
then having a bit of cash is probably no bad
thing because it will throw up some very interesting investment opportunities.
Speaker 2 (39:36):
Yeah, Roger will have to give the studio back soon.
But I just want to ask you a couple more things.
In the first is is this contagious? Obviously, as we
said at the beginning, while we're paying more to borrow
than most of all of the G seven missions, nonetheless,
on paper are our debt to GDP races are not
particularly worse than other countries. So easy to possibility that
if we reach some kind of fiscal crisis point in
(39:57):
the UK that then causes so and bond investors around
world to go, well, hang on, if the UK can't
get this under control, then maybe France can't either, and
the US can't either, et cetera, etc. And it becomes
a rolling f score crisis.
Speaker 3 (40:10):
Yes, I think that's that's a very good question. Obviously,
local financial markets are very interlinked. There is a competition
for capital between all asset classes. As it happens, I
think the contagion, to the extent there would be contagious,
perhaps the other way around. I think another risk that
we haven't really talked about it is maybe one for
another day. I'm just I did touch on that in
(40:32):
the little mini guilt scaree we had in January. That
was partly because US treasury yields went up, and we
obviously have to compete with capital against them. So the
contagion could be the other way around. A trigger to
this could actually be US treasure yields going up. It
could be concerns about the US deficit. It could be
concerns about presidential interference in the FED and the independence
of the FED could cause international investors to demand a
(40:54):
higher return from US from the US. Now, as it happens,
the US treasure yields have actually recently stable. At the moment,
some of those concerns perhaps have passed, So there's certainly
a contagion the other way around that if something happens
bad in the US debt market, then it would almost
certainly have an impact on US. Likewise, another potential scenario
(41:14):
which could cause contagion JGB, so Japanese government bonds. If
the inflation outlook in Japan continues to be persistent, then
jgb's will go up, yields will go up. And again
this idea that everything's interlinked and all of sovereign debt,
all of G seven sovereign debt goes up. So there
are other factors here now, specifically on France and the UK,
because obviously we are the two countries that are a
(41:35):
rioter or in France for instances, right in the eye
of the store, anyone who thinks that what I've just
described is unreasonable or inconceivable, we only have to look
nineteen miles away across from France and see that the
political disarray that they're enduring now. France is in a
slightly different situation to us. Obviously, it's part of the
euro and it has the ECB sitting behind it. I
(41:58):
think to an extent there is less of an element
of contagion because of the ECB has more leavers to
full leavers to poor. Because it's it's managing a zone
of multiple different economies. So to an extent, I think,
and this isn't particularly scientific, but to an extent, French
(42:18):
government debt is slightly more protected because of the ECB
as opposed to us on our own with just the
Bank of England behind us. I think we have seen
some very clear correlation between French oaths and guilt. So yes,
that correlation probably works. I think the interplay between for
US and the UK could be quite interesting in this scenario.
Speaker 2 (42:41):
Concerning should say, Okay, I love the way you use
quite interesting as a euphemism for all sorts of things.
Might make a list of that things, Roger, things are
quite interesting.
Speaker 3 (42:52):
Things that strategist thinks are quite interesting, generally speaking.
Speaker 1 (42:55):
Are bad.
Speaker 2 (42:56):
Yeah, and the rest of us would call absolutely terrifying.
Speaker 3 (43:00):
And the more interesting and exciting markets get is usually.
Speaker 2 (43:03):
The word it is your living standards. Listen, let me
just ask you one last question. Forty finished, are you
reading anything interesting at the moment, reading a good book
fiction and nonfiction that maybe our listeners should be picking up.
Speaker 3 (43:18):
I'm a bit of a nerd on this sort of
things I'm reading we like I'm reading Dominic Sandbrook's History
of the nineteen seventies.
Speaker 2 (43:24):
Oh, I've read that so good? What's so good?
Speaker 3 (43:28):
Two volumes of it? Yeah, and I'm almost through one
volume of it, so yeah, No, I think that's very interesting.
And again you can probably hear tell where I'm heading
on this, but I over the summer I read Philip
Zeigler's biography of Ted Heath, so you.
Speaker 2 (43:40):
Could obviously, Okay, I can see exactly where my.
Speaker 3 (43:42):
Thought process is going here at the moment.
Speaker 2 (43:44):
So yeah, maybe go back and listen to this podcast
on Gold everybody, Roger, thank you so much for joining
us today. We usually appreciated.
Speaker 3 (43:52):
Thank you.
Speaker 2 (44:00):
Thanks for listening to this week's Marin Talks Money. If
you like our show, rate review, and subscribe wherever you
listen to your podcasts. I keep sending questions or comments
to Mirror Money at Bloomberg dot net. You can also
follow me and John on x I'm at Marins w
and John is John Underscores Epic. This episode was hosted
by Me Maren's Sunset Web. It was produced by Summersidi
and Moses and sound designed by Vick Naples and special thanks,
(44:22):
of course to Roger cle
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:17):
Welcome to Meren Talks Money, the podcast and its people
who know the markets to explain the markets. I am Meren,
Somerset Web. We are recording this episode on September twenty fourth.
Now this week I am speaking with Roger Lee. Roger
is currently head of equity Strategy at UK based investment
bank Cavendish. He's been in the equi market for a
long time, nearly thirty years, spending time at HSBC, Deutsche
(00:38):
Bank and JP Morgan. Most recently he was head of
the UK equity strategy at Investork. He's got a lot
of experience here. He's covered UK equities, European equities, US
equities and of course crucially he's also a fellow of
the Institute of Chartered Accountants, a physics graduate, and a
frustrated politician. How's that for an intro. Roger, thank you
(00:59):
so much for joining us today. I think we might
all be frustrated politicians.
Speaker 3 (01:04):
Oh thanks, thanks very much for that wonderful introduction. In
factor frustrated politician in fact, the least successful politician ever
because I tried to get selected twice and failed both times,
dismally frustrated, but not so frustrated now I have to say.
Speaker 2 (01:19):
Yeah, no one wants to be a politician right now,
and that is exactly what we're going to talk about.
And one of the reasons that I asked you on
Roger Bisk is I've read some of the things that
you've written about the fiscal situation of the UK and
just how bad it is and whether there is a
possibility that it is so bad that it genuinely does
cause a fiscal crisis and possibly the downfall of this
government in the UK. So it seems an extraordinary thing
(01:40):
to say, given that this is a government with a
huge majority. We look at them and you think, well,
surely they'll go a full term. But actually, of course,
as my colleague John Steppeck always says, we must try
to think of this less as a majority government than
a coalition government because of all the different viewpoints inside
the tent, and with that in mind, and the fiscal
position in things may be a little bit more tenuous
(02:01):
than perhaps our Prime minister would like to think. So
why don't we start by looking at the fiscal position
in the UK and just run us through quite how
bad this is.
Speaker 3 (02:13):
Let's just step back for a second and just think
what a fiscal event is.
Speaker 1 (02:17):
Now.
Speaker 3 (02:18):
Most of us have lived through a fiscal event, which
was clearly Lisztrust back in twenty twenty two, and a
fiscal event is usually considered something when the guilt market
gets very concerned and guilt yields rise very rapidly. In
that particular instance, guilt yields went up one hundred basis
points or one percent in a four day period and
(02:40):
there had to be some sort of intervention from the
Bank of England. And clearly European sovereign debt crisis was
a series of fiscal events. They are uncommon, but they
do happen, and it's usually characterized by government debt yields
going out very rapidly, So that is a fiscal event. Now,
again for background, there have been since this government came
(03:01):
into power, there have been three mini fiscal events where
guilt fields have gone up twenty basis pointser point two percent,
so not anywhere near the one hundred basis points that
you would cause some problems, but they have moved very quickly,
in some cases in a matter of hours. And the
three occasions were immediately after the October budget last year
when the market got very concerned about growth outlook and
(03:24):
increased issuance. In January when guilt yields went up partly
because US treasury yields were going up, but also concerns
about growth. And then of course during Rachel Reeves, our
Chancellor's difficult day in the Commons, when gilt yilds went
up twenty basis points in a matter of minutes. We
(03:44):
have had three occasions when there has been some sort
of stress in the guilt market in this administration. And
what I think we're going to talk about now is
what would prompt that to be significantly worse than just
a zero point twenty basis point move. Okay, And so
(04:07):
what I think prompted this and what is I think
has prompted a lot of people's interest in what might
happen is really following on from the public sector net
borrowing numbers now to older listeners, that is used to
be called the public sector borrowing requirement. So if I
do mix the two up, they are essentially the same.
So the public sector net borrowing requirement is really the
(04:29):
funding requirement that the government has, or at least in
this particular instance, it's obviously a deficit is that the
government is spending more than they are receiving in tax revenues,
and the OBR and the ONS publish this data every month. Now,
in August, which was the data that was published last Friday,
it was clear that the government is spending a lot
(04:51):
more than they're generating in tax revenue. In fact, I'm
not going to burden you with too many numbers, but
I'll just give you some sort of context here. In August,
the government had to borrow or the deficit between spending
and tax revenue was eighteen billion pounds. Now, that compared
to an OBR forecast for the month of just under
(05:12):
thirteen billion pounds, so forty percent overshoot. Now, that in
itself is not necessarily a problem. What is a problem
is that for the first five months of the year,
spending has overshot tax revenue by sixteen billion. That's for
(05:33):
five months. Now, this isn't particularly complicated, so just bear
with me. But if the government has overspent by sixteen
billion in five months, that's just over three billion a month.
If that run rate continues for the year, then that's
clearly thirty six or thirty eight billion rounding up, So
let's call that forty billion of overspend for the year. Now,
(05:59):
that again isn't necessarily a problem, except compared to what
the OBR are forecasting for the debt for this year.
So the OBR are forecasting that debt levels actually start
to come down, or the rate of the deficit slows
towards the end of the year. There's always this kind
(06:21):
of seasonal effect in this as well, because we are
payout taxes in January, so borrowing does come down seasonally.
But they're expecting debt to come down significantly from last year. Again,
I'm sorry to give you some numbers, but I can't
text it. I'm threatened. So last year the government borrowed
about one hundred and fifty billion. That was the deficit
(06:42):
last year, one hundred and fifty billion pounds, and this
year the OBR are forecasting the deficit to be around
one hundred and twenty billion pounds, so clearly less.
Speaker 2 (06:53):
Than Okay, hang on, to take me back a bit,
how does that connect to the forty billion we were
just talking about. I thought you said it was going
to be around forty billion by the end of the year.
Speaker 3 (07:00):
So we're currently overspending by forty billion if we annualize
the current overspend. But the OBR is expecting debt to
be lower this year than the.
Speaker 2 (07:14):
Last year, so they're expecting it to turn into an
underspend over the next seven months.
Speaker 3 (07:18):
Yes, or they're expecting the revenues to pick up and
spending to slow. Absolutely. So the question I think people
are beginning to ask themselves is what if spending doesn't slow,
What if tax revenues don't increase. What happens if we
(07:39):
carry on spending at the same rate as we did
last year. Now, if that is the case, then last
year we spent or overspent by one hundred and fifty pounds,
So if we have the same outturners last year, that
is still more the and the OBR are forecasting. But
(08:03):
as we stand today, we're spending all the deficit is
higher than it was last year. So there are two
issues here. One why will the deficit come down in
the second half of this year? And secondly, if it
doesn't come down and the deficit run rate continues as
(08:26):
it is in the first five months of the year,
then the conclusion is that the deficit will be one
hundred and fifty billion if it was the same as
last year, but including the overspend or the increased deficit,
increased run rate, however you want to describe it, that
is an additional forty billion pounds.
Speaker 2 (08:47):
Okay, now we get to that turn.
Speaker 3 (08:49):
So the outturn could an ice stress could be closer
to one hundred and ninety billion of deficit, not one
hundred and twenty that the OBR are forecasting. So that
is the kind of the punchline here, And it is
(09:11):
not just me doing the numbers. And as I say,
this is just purely arithmetic. It's not a forecast, it's
not our house view, it's not a central case. It
is just merely extrapolating the arithmetic that we've seen over
the last five months and making a not unreasonable assumption
(09:32):
that the deficit this year is going to be closer
to the deficit that we saw last year, and then
adding that overshoot onto us.
Speaker 2 (09:40):
Okay, let's carry on with this terrifying conversation by talking
about what it is that the OBR expects to bring
tax revenues up and spending down over this year and
the extent, which is that may or may not happen.
Are they expecting an increase in tax revenues for example.
Speaker 3 (09:57):
So there are essent three areas where the OBR are
forecasting that tax or forecasting both tax will be higher
and spending will be lower. And we can discuss the
likelihood of whether this will actually come to pass. But
the three areas that they're talking about is that capital
receipts capital tax receipts will be higher in this fiscal
(10:19):
year than last year. Now most economists think that might
be the case. There is a possibility that could be the.
Speaker 2 (10:27):
Case, and that would be the case. Sorry, just to interrupt,
that would be the case. Why because the rate has
gone up, and because with markets doing very well, etc.
And more people will be making capital gains because people
are beginning to sell, for example, by to let properties
they've held for quite a long time, and there'll be
a rade of capital gains coming from those. So all
these things combined, I think.
Speaker 3 (10:46):
That's the general argument. Yes, yeah, thank you. The second
area where the OBR think that the deficit will start
to fall is because lower debt interest, that is, the
debt interest that the government have to pay to issue
new guilts into the market. Now that the OBER, again
(11:08):
broadly speaking, forecast tenure treasury yield are ten year guilt
yields to be four and a half percent. Guilt yields
are already higher than that today.
Speaker 2 (11:18):
What are they today at four point seven.
Speaker 3 (11:23):
And obviously thirty year guiltields are even higher at close
to five and a half percent. So it is very
difficult to see how lower funding costs are going.
Speaker 2 (11:36):
To help.
Speaker 3 (11:39):
This deficit issue. In fact, if anything, it will be
the reverse. And the third area that the ober are
still believing the world reduced the deficit, and this is
a spent on the spending line again, is that they're
expecting lower growth in welfare spending. Again, it's difficult to
(12:00):
see how that is going to be the case, given
that the welfare cuts that had been proposed clearly were
rejected by the Labor Party back in July. So it's
difficult to see why this deficit is going to come
down in the second half.
Speaker 1 (12:20):
Now.
Speaker 3 (12:21):
What is perhaps easier to see is if the economy
continues to slow as it's doing at the moment, and
if the labor market continues to deteriorate, and we source
some disappointing survey data earlier on in the week, If
the employment market continues to slow, then growth will slow
(12:42):
and therefore tax revenue will slow. So the income side
of this might slow because of slowing growth, and the
expenditure side might rise because of increased welfare payments in
order to support those who are no longer in work.
I've already seen an element of this in last Friday,
(13:03):
which again I think is why last Friday's PSNB numbers
were so interesting is we've already seen an element of
this because one of the reasons that the Ober said
for this overshoot in the deficit or overshoot in the
borrowing requirement was because of lower VAT receipts. Now, lower
VAT receipts are directly linked to demand, they're directly linked
(13:28):
to growth, and they're directly linked to consumer confidence. And
so what we're already seeing is that lower demand feeding
through into lower purchases, lower basket sizes, and that is
feeding directly through into lower VAT receipts. And AVIAT is
one of the largest tax generators in the UK. Now, again,
(13:51):
this is not a huge surprise, Lord Wolfson in his
next report, which I think you referred to recently in one.
Speaker 2 (13:59):
Of you and I talked about it in one of
our market round ups, because those reports are always incredibly insightful,
so it was not something I wanted to read.
Speaker 3 (14:08):
He's so good, hugely, hugely insightful, And I think you
cited the fall in vacancy rates and the issues that
the lack of vacancies that next now have and the
number of applicants that they have going up. What he
also obviously cited right at the front of the report
in his outlook statement was that he's concerned about slower
(14:29):
consumer spending now that is already directly seen by the
OBR in those lower V eight receipts. So again it's
not a question of being sort of sensation list in
any way. It is just know. What the ABR said
on Friday was that net debt or debt had exceeded
(14:53):
expectations by some forty percent, and the reason for that
there was also elements of local authority thing, which is
quite technical and has a habit of reversing anyway. But
also but what was very tangible was lower V eight receipts. Now,
I'm not sure anyone out there is forecasting a huge
search in growth for the remainder of this year. In fact,
(15:15):
I would suggest that most people that are forecasting the reverse.
Most economies are forecasting the reverse.
Speaker 2 (15:20):
So sorry, carry on.
Speaker 3 (15:25):
I was I was always just going to conclude that
if anything, the risks to given the risk to the economy,
the risk therefore would would suggest that the actually tax
revenue will be less than the A B R are forecasting,
and also even less than last year, and the risk
(15:47):
that wilfire spending will be higher.
Speaker 2 (16:05):
So for this to turn around, for the math to
pan out differently, we either need a sudden, very unexpected
surgeon growth, a sudden, also very unexpected massive decline in
our spending, particularly on welfare, which is the obvious area study,
or a sudden collapse in interest rates in guilt rates,
and none of those things seem very likely right now.
Speaker 3 (16:25):
Yeah, well, that's an interesting one. Absolutely, to an extent.
Government finances are very straightforward. They are very similar to
our own personal finances. They have income from tax revenue,
they have expenditure, which is what their spending programs are,
and if there is a gap between the two of
them a short for then they have to borrow. That
is no different to any of us in terms of
(16:46):
how we fund our data day expenditure. Now, instead of
going to a bank. Clearly they do. They go to
the Bank of England and or the Debt Management Office
and they issue guilt. Now, one of the reasons why
this is bound perhaps more relevant now and certainly why
we have started talking about it a bit more. I
stress again that this isn't necessarily a forecast. One of
(17:09):
the reasons we have talked about a bit more is
because our view was is that interest rates were going
to fall quite sharply towards the end of the year.
So our view was slowing economy as a result of
the corporate changing behavior as a result of the last
budget and the National Living Wage would result in a
slowing economy, which is what we're seeing. There would be
a response in the labor market, which is what we
(17:30):
are seeing, and therefore the Bank of England would cut raids. Now,
the Bank of England are clearly not going to cut
rates because inflation is still very elevated in the UK
three point eight percent, and arguably a lot of that
is to do with the pass through of the National
Living Wage and the national insurance contributions, particularly in the
(17:51):
food sector and energy prices related to net zero, which
again I think you've discussed at some detail in a
recent PODCAG so I won't go down at and not
going to add anything to that, suffice it to say
so it locks in the market, certainly not expecting any
interst rate cuts anytime soon. In fact, maybe only one
more this year. Now that's very different to the forecast
that we would have had two or three months ago. Yeah,
(18:13):
that's so, that makes a big difference, and that is
what has changed. What has changed is that we would
have thought that the Bank of eng That were going
to be able to cut rates quite aggressively. There is
a fairly strong correlation between falling into strates and improving
growth that would have stimulated the economy, and that perhaps
would have been the surprise that you were just talking about.
(18:35):
That perhaps would have been the surprise that you would
have seen in terms of both the growth and therefore
the tax take and obviously reduced wealthare spending and more important,
perhaps reduced and clearly that would have had an impact
on guilt yields now in terms of where the curve
would have gone, and that would have reduced the funding
cost it. So, if you wanted to really pin down
(18:57):
what has changed, two things changed. One is that the
interest rate cuts aren't likely, and we would certainly agree
with that as well in the short term. And secondly,
what's changed is the current spending dynamic is a lot
worse and tax take dynamic is a lot worse than
(19:18):
we were expecting. And it's those two stroke three factors
that have changed.
Speaker 2 (19:22):
Yeah, and the marketer has definitely noticed this. I've talked
about this a lot on the podcast. But the fact
that debt costs in the UK are at the moment
they are still higher than any other G seven economy.
So even though our debt situation on the face of
it is not necessarily worse than some other developed economies,
we're still paying we're paying more for our debt than others.
Speaker 3 (19:41):
Irrefutable on a thirty year basis. In the ustrum some
structural issues around the thirty year bond yielding, thirty year
guilt yields. Now just give some context for this. Compared
to the G seven for the thirty year bond yield,
it's just around to five and a half percent. The
US thirty year, which is the next highest, is four
point seven percent.
Speaker 2 (20:01):
Yeah, it's a big difference.
Speaker 3 (20:02):
It's a very significant difference. Now there are I stress
some structural reasons why that may be the case, but
nonetheless it is quite clear that the global capital markets,
which is where we get most about funding from, because
up until now, relatively few people in the UK own
guilts that we tend to save through bank deposits rather
(20:23):
than buying guilts that is a compare and contrast with
other countries, So we are very reliant on the international
markets in order to fund this deficit, in order to
fund our borrowing, and so therefore we are also very
prone to how international bondhields move. But as things stand
at the moment, the markets are clearly demanding a premium
for a number of reasons, possibly this risk that we're
(20:45):
talking about, and is partly that.
Speaker 2 (20:48):
Okay, So the question then that brings us to the
crunch of the whole thing is how long before things
get worse? And as we know, we've been talking on
this podcast and various other places where John and I
have written and spoken for years about the massive build
up of debt across the developed world and how uncomfortable
it is not just here but elsewhere. And we know
you learn from how long you talk about it, that
(21:09):
these imbalances can build up and up and not be
a problem, and not be a problem, and not be
a problem. Everything's fine, and it goes on for much
longer than you could possibly imagine, and then suddenly it turns.
And when it turns, it also turns much much faster
than you could conceivably imagined before it actually happened. That's
how we get We give, we become complacent, and then kubum,
(21:29):
everything goes horribly wrong. And in a situation like this,
you get to the point where the market says, well,
we'll hang on. It's costing you so much just to
serve at the stet you're in a big part of trouble.
And so what happens next? How do we get to
this point?
Speaker 3 (21:43):
Okay, well, there's a great quote, and I hope you
haven't used this too recently, but there's a great quote
that in economics, things happen slower than you would have thought,
and then faster than you thought they could Exactly, I
think is just so true. But what happens next? Now, again,
just for the benefit of your life, listeners, is now.
Speaker 2 (22:01):
A forecast not a forecast.
Speaker 3 (22:04):
We're now just describing a possible scenario of what happens next.
Maybe you will indulge me in this flight of fantasy,
and I'll leave you to judge how real or not
this may be. Now again, I have to give some
credit here to Andrew's sentence and some of his great
ex posts are on this, and he seems to think
(22:27):
that this event could happen in Q three or Q
four this year, and I'm going to just briefly talk
about why that could be the case. So it comes
back to this public sector net borrowing number that comes
out every month. Now, if the debt profile of the UK,
or the deficit profile of the UK continues on its
(22:50):
current trajectory, as we talked about in some detail a
few minutes ago, and it doesn't come down as we
were suggesting, then each month we will get an overshoot
to what the auber are forecasting. At some point, the
market may extrapolate that through using the arithmetic that we
have very simplistically done just a few minutes ago, and
(23:14):
they may come to the same conclusion that if the
run rate continues and the debt profile this year, deficit
profile this year is the same as in twenty twenty
four or five, and therefore we have a one hundred
and ninety billion, or as android sentence described, one hundred
and eighty five, so pretty close to our arithmetic. Now,
(23:35):
that is a very big number. Again, I'm going to
throw your listeners another number here. The total size of
the UK economy is around two point seven trillion pounds,
so two hundred billion of deficit is around seven percent
of GDP. Wow, I mean that is a huge number. Huge.
(24:00):
So of course, just to reference that, the ECB in
as part of the euro criteria in system around a
three percent deficit, and that would normally be what a
normal economy should run at. These are just huge numbers. Now,
if the guilt market remotely felt that the UK deficit
(24:24):
was anywhere close to that number and therefore had to
be funded by increased issuance, given that the last three
occasions when there was a threat of increased issuance, the
guilt market moved by twenty basis points point two percent. Suddenly,
confronted with one of the worst deficits in the Western
(24:45):
world and a funding requirement of something like eighty billion
or seventy billion more than the OBR are forecasting more issuance,
therefore price must ad just to that increase supply and
guilt yields. The price of guilt will fall and the
(25:06):
yields will rise, and this is how you get into
this potential guilt yield spiral. So guilt yield start to
rise in order to compensate the guilt holders for obviously
more issuance is a simple supply demand dynamic, and at
this point, then guilt yield start to rise. Now the
(25:28):
problem you get, and there were some very specific instances
around us, but what you then get is the cost
of funding goes up as guilt yields go up. We
talked about that briefly. It's one of the big swing
factors in the government's p and L and finances. So
(25:48):
guilt it'd start to rise, that increases the funding costs,
That therefore increases the deficit, which means more issuance, So
therefore guiltields go up again. This is when you get
into the crisis of more issuance, higher yields, more issuance. Repeat.
It's a vicious spiral and we've seen evidence of this
(26:11):
around the world many times. And that then is the
problem that the government will have to deal with. What
you would expect to happen, and this is getting to
the rub of this discussion, you would then expect the
Bank of England to wintercede. Now, the primary duty of
the Bank of England is a financial stability yields moving
(26:35):
very rapidly. Again, we can remember what out in trust
mortgages get withdrawn, financial markets start to suffer significant stress.
Speaker 2 (27:00):
Number would you put on guilt yields for it to
hit the kind of level of crisis at the Bank
of England would intervene.
Speaker 3 (27:06):
Oh, it's about one hundred basis points would probably be
sufficient to cause this. And that's not based on sort
of any scientific measure. It is merely observational of what
happened during the trust what happened guilt yelds body yields
in the periphery during the period of the European sovereign
det crisis went up a lot more than that. I mean,
(27:28):
you do treasure olds getting to four point nine percent
in January, as I said this morning, the four points
around four point seven. They got about four point nine
percent in January, and that was beginning to raise alarm bells.
If they went to five point seven, then I think
you have a problem, okay, And I think most people
would think you would have a problem. At that point
(27:49):
that would be thirty year guilt yields at six and
a half percent. These are big numbers and so at
this point in this scenario, the Bank of England would
be required or as part of its mandate, to ensure
financial stability in the UK, and therefore would have to intercede.
And the intervention would be again similar to what we
(28:11):
saw with Trust, and that is that they would start
some sort of Q program. They would start backstopping the
guilt market. They would start buying guilt so that completely
reverse their QT and have to start buying again. And
they have the capacity to buy and do whatever it
takes to use those words in order to stabilize the
guilt market. The question comes at what price they would
(28:35):
expect the government to pay for that? And I don't
mean a financial price necessarily, but what financial discipline will
they impose on the government. And again this is purely
hypothetical fantasy, but it is difficult to imagine that the
Bank of England would be happy to backstop a situation
(28:55):
like this unless there was a significant can display a
fiscal restraint by the government, and I don't think that
is unreasonable. The risks of not forcing fiscal restraint on
the government would jeopardize the reputation of the Bank of
England as a fiscal constodient of our finances and.
Speaker 2 (29:17):
Such as it is, such as it is.
Speaker 3 (29:20):
And I you not your words, not mine, and I
think that I think given their sort of recent track record,
I think the last thing that the Bank of England
would want to be accused of is fiscal irresponsibility. Would
what normally happens here and again what we've seen in
the periphery is that the Bank of England will insist
(29:41):
on fiscal restraint and fiscal responsibility. So, just going back
to those numbers I just talked about a two hundred
billion deficit. Huge is a seven percent fiscal deficit for
the UK. You could easily see the Bank of England
insisting that behalved, and they would insist on that as
part of this backstopping of the UK guild market.
Speaker 2 (30:05):
You get to the point where that.
Speaker 3 (30:07):
That is now getting into sorry, and that is now
getting very painful for any sitting government. Again, just to
give you the numbers, so that would be around deficit
at that point, let's say keep the numbers very simple,
be around two hundred billion and the banking will probably
potentially insist on that deficit being halved two hundred billion
(30:28):
through some sort of emergency budget.
Speaker 2 (30:32):
And this then, because where you run decision Okay, so
then we go from maths to politics. So you get
to the point where the government has to take an
emergency budget to Parliament and ask its MPs that very
large majority to sign off on one hundred billion quidsworth
of cuts, a large amount of which would presumably because
(30:53):
it's got to be quick, probably full on welfare I'm
guzzing here, plus probably a sharp rise in an immediate
rise in income tax to cover quite a lot of it.
And you're going to ask people who've promised in their
manifesto not to raise income tax and to as a
party prefer to increase rather than degrees welfare spending. And
(31:14):
then suddenly you get a budget that doesn't pass and
you have a proper all crisis.
Speaker 3 (31:19):
Yes, that's that is very succingly port I think that
is the issue. And again we can put some numbers
about that and some sort of recent precedence to it
saving one hundred billion pounds very quickly. That's the sort
of austerity level that Osborne and Cameron did a post
(31:40):
financial crisis in terms of over over several year period
to get that into some sort of one hundred billion
into some sort of context. As well, a penny on
income tax raises about ten billion pounds, So you know,
as you said tax risers, you could easily see a
basic great of income tax going up several pence to this,
(32:01):
and then you've got to address the welfare side of
the equation. So let's say half of this was paid
for by tax risers and the other half paid by
spending cuts. That's fifty billion pounds worth of spending cuts.
On one level, we spend about one point three trillion
in the UK, so that is clearly less than a
(32:22):
five percent cut. But politically, as you will recall from July,
the government we're unable to get five billion pounds worth
of spending cuts through, and we're now talking a figure
hypothetically of ten times that amount. This would be very challenging.
I would have thought for the parliamentary Labor Party to
(32:45):
vote through very challenging. And it's this scenario that then
leads to an interesting constitutional question. Clearly I'm not remotely
pretending to be a constitutional expert, but if a government
is unable to pass this emergency budget because they're sitting
(33:06):
MPs refuse to do it, and this actually may be
an unintended problem of having such a large majority. If
they are unable to pass this budget, then convention suggests
that at that point the government have to dissolve parliament
and go to the country and have a general election.
(33:29):
It's only happened once in the UK in nineteen oh nine,
as it happens, but so we do have to go
back quite a long time. I wasn't even in the
market then and it has only happened once, but it's
happened on a number of occasions in parliamentary systems that
have a similar structure to Westminster. So being unable being
unable to pass a budget is clearly fundamental to how
(33:51):
you govern a country. And so if they are unable
to pass a budget, then one would expect at that
point a general election to be called and enters into
a whole realm of other topics.
Speaker 2 (34:03):
Yeah, that would take us test straight onto what happens
after that, which might be outside the scope of our
imagination of Nigel Farah just talking about or thinking about
expecting an election, and maybe twenty twenty seven. Maybe he
might get his wish, and that would all be rather interesting.
I mean, the key point being that you've run us
through maths as opposed to politics. You've run us through
(34:23):
what could happen given the numbers, as opposed to what
anybody might want to happen. But nonetheless, it does feel
that we are getting to this point where very slowly
and then very quickly, and at some point either something
massive has to change or we do need a crisis
that forces that change. So there's a growing sense of
inevitability of running at the edge of the cliff, isn't there.
Speaker 3 (34:43):
Yes, I don't think. No one's pretending that the fiscal
situation in the UK is anything other than challenging. That
is not a remotely contentious point to make, I don't think.
And also I am not sure. And again I'm not
sure this is a particularly contentious point either, that this
(35:03):
situation of ever increasing taxes at the same time as
ever increasing welfare spending without any growth is probably unsustainable.
Speaker 2 (35:15):
Well, it does get very difficult when you have no growth,
because when there is no growth in an economy, you
are constantly shifting the pieces of pie around between people,
right and that is obviously going to cause conflict for us.
When you have growth, there's more pie to share, so
you don't get quite the same level of well anger
as you do when there is no growth. The lack
of growth is in itself a thing that creates conflict, right, Oh.
Speaker 3 (35:36):
Yes, it is. The lack of growth is the problem.
The government are absolutely right to focus on growth, as
was list trus. It's a question of how you achieve growth.
But growth answers all of these problems. The problem is
at the moment, we don't have any.
Speaker 2 (35:52):
Okay, now let's move on from this. Potentially you call
it a it's not a zero risk event. It's slightly
quite a lot more than zero at this point. But
let's say that this is out there as a possibility.
If this happens, if we end up in this kind
of scenario, and again, so many moving parts, None of
this can be sure. These are, as you said, not forecasts,
(36:14):
simply as suggestions of possibilities. But if we do get
this situation, when we have both a fiscal crisis and
a constitutional crisis concurrently, what happens to markets, all that
nice growth we've seen in the UK equitity market, It
just leaves us in a wanner. What happens.
Speaker 3 (36:30):
That's probably the easiest question to answer that you will
post me all day. They will go down. They will
go down a lot. So let's just that's actually a
bit of a facile answer, because some bits of the
market will go up a lot and some bits of
the market will go down an awful lot, and that's
what we see. So let me just answer that, give
(36:51):
me some give you your listeners a couple of ideas
here and what happens if we know what happened in
the two hours after Rachel Reeves's difficult day in Parliament,
we don't obviously know what happened in the market then.
And what happened was that the metals and mining sector,
which obviously is international learners and it has gold within
(37:15):
that and it has copper. That sector went up. I
can give you the exact numbers. That sector went up
four percent over that two hour period. The UK real
estate sector and the UK house building sector went down
six So in two hours there was a ten percent spread.
These are big numbers. And we also saw you can
(37:38):
go back to trust and see what happened there is
that generally speaking, the two point fifty, The forty two
to fifty, which is very much more domestically exposed, went
down a lot, and the forts one hundred, which is
obviously more internationally exposed, went down, but not as much
because of clearly it has dominated by companies that have
(38:01):
international earnings. Now that's not a complete defense in this
environment because obviously it's the UK that the market is
very concerned about at this point, and so even those
international earners tend to fall, but just not as much
as the domestic place. So we see the market moves.
You know, these market moves are very pronounced, they are
(38:23):
quite dramatic, and they are also quite extreme. But before
that sounds all too frightening, there's also another aspect of
this that is often ignored is that market crises do pass, yes,
and they do pass. The tools are there. They may
(38:44):
be painful for the current administration to administer, but someone
will have to administer them, and that then creates a
very interesting opportunity going forward, just as during trust created
a very interesting opportunity for those who are able to
or nimble enough and have the courage to buy through
(39:04):
the crisis. The opportunities that result from this can be
quite profound.
Speaker 2 (39:09):
So it's worth holding It's worth holding a little cash,
a little more cash than you might have otherwise, next
to your gold obviously, and the emeralds you're going to
put in a hem of your skirts.
Speaker 3 (39:20):
Yes, not to give financial advice, but the writing having
a bit of cash at the moment is certainly could be.
If one is concerned about the outcome of this outcome,
then having a bit of cash is probably no bad
thing because it will throw up some very interesting investment opportunities.
Speaker 2 (39:36):
Yeah, Roger will have to give the studio back soon.
But I just want to ask you a couple more things.
In the first is is this contagious? Obviously, as we
said at the beginning, while we're paying more to borrow
than most of all of the G seven missions, nonetheless,
on paper are our debt to GDP races are not
particularly worse than other countries. So easy to possibility that
if we reach some kind of fiscal crisis point in
(39:57):
the UK that then causes so and bond investors around
world to go, well, hang on, if the UK can't
get this under control, then maybe France can't either, and
the US can't either, et cetera, etc. And it becomes
a rolling f score crisis.
Speaker 3 (40:10):
Yes, I think that's that's a very good question. Obviously,
local financial markets are very interlinked. There is a competition
for capital between all asset classes. As it happens, I
think the contagion, to the extent there would be contagious,
perhaps the other way around. I think another risk that
we haven't really talked about it is maybe one for
another day. I'm just I did touch on that in
(40:32):
the little mini guilt scaree we had in January. That
was partly because US treasury yields went up, and we
obviously have to compete with capital against them. So the
contagion could be the other way around. A trigger to
this could actually be US treasure yields going up. It
could be concerns about the US deficit. It could be
concerns about presidential interference in the FED and the independence
of the FED could cause international investors to demand a
(40:54):
higher return from US from the US. Now, as it happens,
the US treasure yields have actually recently stable. At the moment,
some of those concerns perhaps have passed, So there's certainly
a contagion the other way around that if something happens
bad in the US debt market, then it would almost
certainly have an impact on US. Likewise, another potential scenario
(41:14):
which could cause contagion JGB, so Japanese government bonds. If
the inflation outlook in Japan continues to be persistent, then
jgb's will go up, yields will go up. And again
this idea that everything's interlinked and all of sovereign debt,
all of G seven sovereign debt goes up. So there
are other factors here now, specifically on France and the UK,
because obviously we are the two countries that are a
(41:35):
rioter or in France for instances, right in the eye
of the store, anyone who thinks that what I've just
described is unreasonable or inconceivable, we only have to look
nineteen miles away across from France and see that the
political disarray that they're enduring now. France is in a
slightly different situation to us. Obviously, it's part of the
euro and it has the ECB sitting behind it. I
(41:58):
think to an extent there is less of an element
of contagion because of the ECB has more leavers to
full leavers to poor. Because it's it's managing a zone
of multiple different economies. So to an extent, I think,
and this isn't particularly scientific, but to an extent, French
(42:18):
government debt is slightly more protected because of the ECB
as opposed to us on our own with just the
Bank of England behind us. I think we have seen
some very clear correlation between French oaths and guilt. So yes,
that correlation probably works. I think the interplay between for
US and the UK could be quite interesting in this scenario.
Speaker 2 (42:41):
Concerning should say, Okay, I love the way you use
quite interesting as a euphemism for all sorts of things.
Might make a list of that things, Roger, things are
quite interesting.
Speaker 3 (42:52):
Things that strategist thinks are quite interesting, generally speaking.
Speaker 1 (42:55):
Are bad.
Speaker 2 (42:56):
Yeah, and the rest of us would call absolutely terrifying.
Speaker 3 (43:00):
And the more interesting and exciting markets get is usually.
Speaker 2 (43:03):
The word it is your living standards. Listen, let me
just ask you one last question. Forty finished, are you
reading anything interesting at the moment, reading a good book
fiction and nonfiction that maybe our listeners should be picking up.
Speaker 3 (43:18):
I'm a bit of a nerd on this sort of
things I'm reading we like I'm reading Dominic Sandbrook's History
of the nineteen seventies.
Speaker 2 (43:24):
Oh, I've read that so good? What's so good?
Speaker 3 (43:28):
Two volumes of it? Yeah, and I'm almost through one
volume of it, so yeah, No, I think that's very interesting.
And again you can probably hear tell where I'm heading
on this, but I over the summer I read Philip
Zeigler's biography of Ted Heath, so you.
Speaker 2 (43:40):
Could obviously, Okay, I can see exactly where my.
Speaker 3 (43:42):
Thought process is going here at the moment.
Speaker 2 (43:44):
So yeah, maybe go back and listen to this podcast
on Gold everybody, Roger, thank you so much for joining
us today. We usually appreciated.
Speaker 3 (43:52):
Thank you.
Speaker 2 (44:00):
Thanks for listening to this week's Marin Talks Money. If
you like our show, rate review, and subscribe wherever you
listen to your podcasts. I keep sending questions or comments
to Mirror Money at Bloomberg dot net. You can also
follow me and John on x I'm at Marins w
and John is John Underscores Epic. This episode was hosted
by Me Maren's Sunset Web. It was produced by Summersidi
and Moses and sound designed by Vick Naples and special thanks,
(44:22):
of course to Roger cle
Host
Merryn Somerset Webb
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