The contents of the mini budget were heavily trailed. But the overall scale of the stimulus – there is to be £72 billion (equivalent to around 3% of the UK’s GDP) of additional borrowing over the remainder of fiscal year 2022-23 – still surprised markets.

Among the headline measures, the Chancellor cut the basic rate of income tax to 19p and abolished the 45% rate of tax for the highest earners. The stamp duty threshold on property purchases was raised from £125,000 to £250,000; a planned increase in corporation tax was binned; and an increase in National Insurance payments that was brought in earlier this year reversed.

These moves follow on from the announcement of the Government’s Energy Price Guarantee, which will see the average household energy bill over the next two years capped at £2,500 annually. An Energy Bill Relief Scheme to limit energy bills for businesses was also announced in recent days.

The government’s pledge to freeze domestic energy bills, cap gas and electricity costs for businesses and cut taxes will result in huge additional borrowing.

In March, the UK Office for Budget Responsibility (OBR) forecast a Central Government Net Cash Requirement, the borrowing figure that directly informs Gilt issuance, of £94.3 billion for fiscal year 2022-23. We now calculate that this could rise to around £167 billion (around 6.5% of the UK’s GDP) – previously, we had expected an increase to £140 billion. The bulk of the increase in borrowing is due to the energy support packages for households (£31 billion) and businesses (£29 billion).

Inevitably, these borrowing projections can only be loose approximations. We may have to await a formal OBR forecast update later in the year for more concrete projections.

Further rises in interest rates

This is a substantial fiscal stimulus and will clearly put additional pressure on the Bank of England to tighten monetary policy. In our previous forecast for the Bank Rate, we envisaged a 3.5% peak in February 2023. This was based on additional fiscal stimulus of around £45 billion in fiscal year 2022-23. The £72 billion fiscal boost in the current year, with further easing to come, has prompted us to revise our forecast for the terminal Bank Rate forecast up to 4.0% (based on 75bp hikes in November and December and a final 25bp rise in February).

Gilt yields will rise further, with 10-year notes reaching 4.5%

One key takeaway from the UK Government’s ‘Growth Plan’ is clear: there will be a substantial, multi-year – and in fact unprecedented – increase in Gilt supply for private investors to absorb.

The government has announced a pandemic-scale fiscal stimulus, with gross Gilt issuance this year set to top £190 billion and, in all likelihood, approach £250 billion in 2023. But unlike during the pandemic, there will be no offsetting monetary policy stimulus (in the form of quantitative easing) to absorb all of the additional issuance. In fact, the Bank of England confirmed on Thursday 22 September that it is set to begin active sales of its Gilt holdings imminently.

There is also a global demand-side shift as investors opt for cash in a high-inflation, low-growth world. For Gilts in particular, it is hard to see major sources of investment demand keeping pace with the vast increase in supply.

Taken together, these effects are likely to exert significant bearish pressures on the Gilt markets in the weeks to come, particularly at the long end of the curve. As a result, we are revising our ten-year Gilt yield target up from 4.0% to 4.5% as the market prices in the deluge of supply and lack of demand. Rising yields will of course pass through to corporate bond markets, meaning higher borrowing costs for issuers of sterling-denominated securities.

The pound will come under further pressure

Sterling’s slump in the immediate wake of the mini budget was unsurprising. The provisions contained within it were only seen to be exacerbating the UK’s already poor twin deficit position, particularly with respect to the current account.

That said, we expect further weakness for the pound, both against the euro and the US dollar. In fact, it’s hard to imagine a feasible policy mix that would persuade the FX markets to drive a rebound in the pound.

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