6 min read 19 Oct 22
Summary: With many of the policies in the mini-budget now discarded, we take a look at what this could mean for you.
The UK’s mini-budget, unveiled on 23 September by then Chancellor Kwasi Kwarteng, resulted in an almost unprecedented wave of financial market distress. The pound plunged to a record low against the dollar of $1.03, while the cost of government borrowing rose sharply.
As a result, consumers were suddenly faced with the prospect of higher inflation as the cost of imported goods rose, and higher interest rates on mortgages and other types of loans, as these move in step with interest rates on government debt.
Remember, you can take a look at our glossary for explanations of the investment terms used throughout this article.
Then just a few weeks later, we saw a change in Chancellor to Jeremy Hunt, and a reversal on many of the mini-budget plans. In a bid to reassure the markets, Hunt delivered an emergency statement to the House of Commons on 17 October.
One way the government generates money to meet its spending commitments is by borrowing, mainly from pension funds and insurers. These companies lend cash to the government over a fixed term (usually five, 10 or 30 years), in exchange for a twice-yearly interest payment, also known as a coupon. At the end of the fixed term, the government pays back the amount it originally borrowed.
Pension funds are attracted to gilts because they’re seen as safer investments than other asset types like equities (shares in a company) as there’s confidence the government will not default, therefore providing a reliable stream of income over the long term to pay the retirees in their schemes.
In the immediate chaos that followed September’s mini-budget, faith in the ability of the UK government to pay the interest on its debts was at a low, pushing up the interest rate at which the government is borrowing. As interest rates are inversely related to bond prices, the rise in interest rates was followed by a fall in gilt prices.
Many final-salary pension schemes (a type of workplace pension that will pay you a retirement income for life) use derivatives in order to help fulfil their payment duties. Derivatives are financial instruments whose value depends on the value of an underlying instrument. They offer access to the changes in the underlying security’s price without owning the actual security, which sometimes means the costs of investing are lower and liquidity (the ability to buy and sell quickly) is higher. Investors need to deposit collateral to invest in certain derivatives.
When gilt prices collapsed, the financial institutions selling derivatives demanded that pension funds deposit more cash to prove they could afford any losses incurred. This left pension funds having to sell more gilts in order to be able to deposit this money. With the vast amount of gilts being sold, their prices fell, further increasing the losses for pension schemes.
These stresses on UK pension funds forced the Bank of England to step in and announce a gilt-buying programme, in a bid to help stabilise the markets. However, the Bank of England could only continue this for a limited period, leaving the same concerns for the aftermath.
Although we do not anticipate retirement pots to be in permanent jeopardy, there's still a concern for those signed up to final-salary pension schemes, where the risk sits with the employer and not the individual. That said, even in the unlikely situation of an employer going bust, it’s important to remember that the Pension Protection Fund provides a safety net.
In September, the Bank of England raised interest rates from 1.75% to 2.25% in a bid to tackle inflation (which measures the rate at which prices of goods and services go up). This saw an almost immediate rise in monthly repayment amounts for homeowners on variable rate deals.
Re-mortgagers and first-time buyers are facing much higher mortgage costs, with fixed-term rates having factored in the latest rise in the cost of money. The start of the year had five-year fixed mortgage rates at around 1%, whereas borrowers are now looking at rates of around 5%.
With inflation continuing to rise, it appears unlikely the Bank of England will cut interest rates anytime soon, thereby high mortgage rate deals are looking likely to stay put for the near-future.
The government will be providing less support with energy bills too. The former Prime Minister, Liz Truss, had previously announced an Energy Price Guarantee to limit the annual bill for households with typical consumption levels to an average of £2,500 for the next two years. However, Jeremy Hunt said this will now only be in place for six months, with an “objective to design a new approach that will cost the taxpayer significantly less than planned, whilst ensuring enough support for those in need”.
Hunt’s speech appears to have eased some previous concerns – the biggest one being about tax cuts without an explanation of where the extra money is to come from. The new Chancellor has outlined that the planned increases in the duty rates for alcohol will now go ahead, rather than being cancelled; original plans to cut the basic rate of income tax to 19% have been scrapped; and households will receive less support for energy bills.
Soon after Hunt’s re-assessing of the mini-budget, the markets have remained stable, providing hope for a calmer environment in the short term at least. Of course, there remains a lot of uncertainty and we wait to see what happens with gilts, mortgages and sterling – but for now, at least, it looks like some stability has come back.
Please bear in mind that M&G Investments are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser. The views expressed here should not be taken as a recommendation, advice or forecast.
The value of any fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.
The views expressed here should not be taken as a recommendation, advice or forecast.
The value and income from any fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that any fund will achieve its objective and you may get back less than you originally invested.