Investments | 08 September 2022

Liz Truss as PM – what can we expect?

The new Prime Minister is talking lower energy bills and, potentially, tax cuts. But will it all come at a price for investors further down the line?

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Number 10 has a new resident and the UK has its fourth Prime Minister in six years. On Tuesday (6 September), Liz Truss was officially appointed to the role having won the race to be the new leader of the Conservative Party.

Here’s what we think a Truss government could mean for the economy, investors and our own clients’ portfolios and funds.

Here’s what we think a Truss government could mean for the economy, investors and our own clients’ portfolios and funds.While this could help put more money into people’s pockets, it could also add fuel to the inflationary fire the Bank of England (BoE) has been trying to put out for the best part of a year. The annual rate of inflation reached 10.1% in July, according to the Office for National Statistics, and markets have priced in that the BoE could raise the base rate to above 4% by the middle of next year. But a government’s fiscal policy can change the path of inflation.An economy experiences ‘stagflation’ when growth is stagnant and inflation is high. It’s an unwanted situation because money is losing value while investments into assets such as shares in companies aren’t making returns because there is such low, or even negative, economic growth.

Stagflation became financially synonymous with the difficulties the UK and other economies faced in the 1970s. The oil producing organisation OPEC embargoed oil exports to many western nations, pushing up oil and energy prices dramatically. The rise in the cost of living, fuelled in part by wage price spirals, coincided with stagnant economic growth, and unemployment was high while things got more expensive. This resulted in stagflation.

Although we currently have an energy shock, especially in Europe, as a result of the Russian invasion of Ukraine, the main driver of today’s inflation pressures was the pandemic. It led to a large demand for goods when strained and locked-down supply chains couldn’t cope. 

Put simply, the path of both growth and inflation at this point depends on what the new Prime Minister does next. It’s obviously still very early days, but Truss’s campaign suggests her economic vision is likely to be focused on ‘supply-side economics’ – a theory that the best way to foster economic growth is to lower taxes, decrease regulation and support free trade.

So she could very well start reducing public spending (except for certain sectors like the NHS) and creating growth via tax cuts for individuals and companies.

While this could help put more money into people’s pockets, it could also add fuel to the inflationary fire the Bank of England (BoE) has been trying to put out for the best part of a year.

The current situation is this: the annual rate of inflation has risen rapidly, and reached 10.1% in July, according to the Office for National Statistics. Markets have therefore priced in that the BoE could raise the base interest rate to above 4% by the middle of next year to try to tame rising prices. But a government’s fiscal policy can very much impact inflation.

A major contributor to the UK’s rising inflation figure is energy. Higher demand for oil and gas post-lockdown, followed by Russia’s gatekeeping of its critical gas supply to Europe in response to sanctions, saw prices soar.

UK energy regulator Ofgem had announced that, from 1 October, the energy price cap would increase to £3,549 per year for dual fuel for an average household.

However, one of Truss’s first acts as Prime Minister has been to fix this cap at £2,500 for two years, from October. Depending on other factors, this means the Consumer Price Index – a measure of inflation – will likely peak in October and then start falling. The full year inflation estimates for 2022 and especially 2023 should also come down significantly. And it reduces recession risks by shielding consumers from further serious drops in real incomes.

Sven Balzer, Head of Investment Strategy at Coutts, said the potential impact of all this on interest rates was two-fold.

“Firstly, lower peak inflation means less need for the BoE to use multiple, large, 0.75% interest rate hikes like the US did. Rates would still rise in the coming months but probably less than markets expect,” he said.

“But on the other hand, a price cap represents significant fiscal support which, alongside other proposed tax cuts, could all together put more medium-term pressure on inflation. People have more, people spend more, and prices go up.

“So basically, it could mean lower rate hikes than the market is expecting for the remainder of this year, but potentially more hikes than the market is expecting next year.”

Earlier in the year, we’d identified a number of headwinds for the UK economy, so we’ve already reduced our exposure to UK equities.

Sven said: “We currently hold fewer UK equities than our benchmarks. We’ve reduced our exposure to UK mid-cap companies which are typically more domestically focused and more vulnerable to an economic slowdown in the UK.

“Where we do have exposure is to large-cap, FTSE 100 companies, which usually derive most of their revenues from outside the UK, often in US dollars, thus benefitting from weaker sterling.”

Additionally, our recent switch from investing solely in UK government bonds to G7 government bonds means a typical Sterling Balanced portfolio now has only 2.7% in gilts, compared to 28% before the change. In August, UK government bonds returned -7.4%, considerably below other G7 government bonds.

We have also leaned more towards investing in US dollars, which has provided further insulation from volatile currency moves and helped mitigate some of the asset price drops in sterling portfolios.

It’s worth reiterating that these are still very early days in Liz Truss’s reign as Prime Minister. We’ll no doubt see further developments once she has her feet firmly under the table.

However, Truss’s initial stance on tackling the cost of living crisis by cutting household energy bills could have a significant impact on inflation, and therefore the BoE’s management of interest rates.

“The challenges the UK is facing should not be underestimated,” Sven warned. “So for now, we maintain a cautious stance on the UK market, as shown by our portfolio positioning.”

  • A Truss government

    Put simply, the path of both growth and inflation at this point depends on what the new Prime Minister does next. It’s obviously still very early days, but Truss’s campaign suggests her economic vision is likely to be focused on ‘supply-side economics’ – a theory that the best way to foster economic growth is to lower taxes, decrease regulation and support free trade.

    So she could very well start reducing public spending (except for certain sectors like the NHS) and creating growth via tax cuts for individuals and companies.

    While this could help put more money into people’s pockets, it could also add fuel to the inflationary fire the Bank of England (BoE) has been trying to put out for the best part of a year.

    The current situation is this: the annual rate of inflation has risen rapidly, and reached 10.1% in July, according to the Office for National Statistics. Markets have therefore priced in that the BoE could raise the base interest rate to above 4% by the middle of next year to try to tame rising prices. But a government’s fiscal policy can very much impact inflation.

  • Energy prices

    A major contributor to the UK’s rising inflation figure is energy. Higher demand for oil and gas post-lockdown, followed by Russia’s gatekeeping of its critical gas supply to Europe in response to sanctions, saw prices soar.

    UK energy regulator Ofgem had announced that, from 1 October, the energy price cap would increase to £3,549 per year for dual fuel for an average household.

    However, one of Truss’s first acts as Prime Minister has been to fix this cap at £2,500 for two years, from October. Depending on other factors, this means the Consumer Price Index – a measure of inflation – will likely peak in October and then start falling. The full year inflation estimates for 2022 and especially 2023 should also come down significantly. And it reduces recession risks by shielding consumers from further serious drops in real incomes.

    Sven Balzer, Head of Investment Strategy at Coutts, said the potential impact of all this on interest rates was two-fold.

    “Firstly, lower peak inflation means less need for the BoE to use multiple, large, 0.75% interest rate hikes like the US did. Rates would still rise in the coming months but probably less than markets expect,” he said.

    “But on the other hand, a price cap represents significant fiscal support which, alongside other proposed tax cuts, could all together put more medium-term pressure on inflation. People have more, people spend more, and prices go up.

    “So basically, it could mean lower rate hikes than the market is expecting for the remainder of this year, but potentially more hikes than the market is expecting next year.”

  • Our positioning

    Earlier in the year, we’d identified a number of headwinds for the UK economy, so we’ve already reduced our exposure to UK equities.

    Sven said: “We currently hold fewer UK equities than our benchmarks. We’ve reduced our exposure to UK mid-cap companies which are typically more domestically focused and more vulnerable to an economic slowdown in the UK.

    “Where we do have exposure is to large-cap, FTSE 100 companies, which usually derive most of their revenues from outside the UK, often in US dollars, thus benefitting from weaker sterling.”

    Additionally, our recent switch from investing solely in UK government bonds to G7 government bonds means a typical Sterling Balanced portfolio now has only 2.7% in gilts, compared to 28% before the change. In August, UK government bonds returned -7.4%, considerably below other G7 government bonds.

    We have also leaned more towards investing in US dollars, which has provided further insulation from volatile currency moves and helped mitigate some of the asset price drops in sterling portfolios.

  • IN SUMMARY

    It’s worth reiterating that these are still very early days in Liz Truss’s reign as Prime Minister. We’ll no doubt see further developments once she has her feet firmly under the table.

    However, Truss’s initial stance on tackling the cost of living crisis by cutting household energy bills could have a significant impact on inflation, and therefore the BoE’s management of interest rates.

    “The challenges the UK is facing should not be underestimated,” Sven warned. “So for now, we maintain a cautious stance on the UK market, as shown by our portfolio positioning.”

Coutts investment clients can find out more about the latest market movements and what they mean by contacting their private banker, visiting our insights page or listening to our latest podcasts.

 

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs. 

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