Merlin Weekly Macro: Labour under mounting pressure after Budget

After an early baptism of fire with the summer riots, this was probably the week in which Labour really began to learn what it is to be in the meat-grinder of government rather than a protest party in opposition.

Headlines of ‘Stagflation’: not what Reeves wants to see

Growth has stalled again and inflation has just jumped by half a point to 2.3%, the highest since April. It is certainly not a disaster but it is in the wrong direction. Labour can’t even blame the Tories for the reversal in price momentum: the principal culprit was the 10% hike in the energy price cap effected in October; the energy cap mechanism was the brainchild of the current Energy Secretary Ed Milliband when he was Labour leader ahead of the 2015 election. It was an idea that was pinched by Theresa May and used to its full degree by Liz Truss (under strong pressure from Labour) to contain gas and electricity prices in the great spike of 2022. The cap is due to rise again in January by 1.2%.

Business and farms: the mounting political fall-out from the budget

Rachel Reeves was determined to stamp her authority with her flagship ‘Securonomics’ budget. The aftermath has degenerated into a pitched battle. The focal point of the budget, the significant change to employers’ National Insurance, has had businesspeople complaining in droves about the cost and Labour’s lack of understanding about the corrosive consequences to employment, wages and investment. If they had been seduced by Reeves and Starmer ahead of the election that Labour’s would be one of the most business-friendly governments in recent memory, many are rapidly concluding that either they were spun a yarn or the Treasury is clueless about how business works, or both. Neither is encouraging.

And what was originally a very brief sentence in Rachel Reeves’ speech about inheritance tax (IHT) has subsequently blown up into a full-scale war with the farming community. It is here that the government is quite quickly tying itself in knots and only making a bad situation worse for itself. Consider: the Chancellor on the Laura Kuenssberg politics programme declaring that ‘we can’t have farmers remaining wealthy while public services are so poor’ and then being forced to deny that she is engaging in class warfare; the Welsh First Minister who told farmers patronisingly to ‘calm down’, only narrowly omitting the ‘dear!’, the Winner-ism which once upon a time landed David Cameron in hot water in parliament; the DEFRA (Department for Environment, Food & Rural Affairs) secretary of state being proven to have made promises he should not have that applying IHT to agricultural assets was not going to happen; the farming minister saying that IHT only applies to 500 estates a year without understanding that nobody can predict when a farmer is going to die and that, in fact, at some stage every farm with assets in excess of £1m is potentially at risk; and finally, most bizarre of all given it is one of Rachel Reeves’s declared aims to recover £5bn of ‘unpaid’ taxes, the rural affairs minister telling farmers to seek tax advice about how to avoid the potential liability.

Finally, and she has only herself to blame for this as she regularly reiterates her ‘I was a Bank of England economist’ credentials as her qualification to be chancellor, a fact-checking investigation into her employment record shows that she has been what is euphemistically described as economical with the truth and allowing a false impression of her experience.

The past three weeks have been an object lesson in the pitfalls of poor fiscal planning, policymakers showing little understanding of real-life fundamentals, and then politically managing to lose control of a narrative while demonstrating ignorance and the sensitivity of a paving slab to a community within which many lives and livelihoods are about to be turned up-side-down.  

Defence, foreign and trade policies: spin the bottle

Aside from the economy, Keir Starmer’s government appears to be all at sea with the shifting tide pushing him this way and that in other policy areas. Take defence, where John Healey is part-way through a major strategic review which will be concluded in Q1 2025; this week he was forced to announce premature defence cuts. However much it makes sense to save half a billion pounds scrapping five naval and support ships, a host of drones and 31 helicopters, even if some are replaced there will be a substantial capability gap. The optics are dreadful. This is a time of acute global tensions. There is a direct threat from Putin against the UK and the US that allowing the use of their long-range missiles by Ukraine against targets inside Russia will have direct consequences. Responsible and knowledgeable people are forecasting a state-on-state war with Russia as a possibility within the foreseeable future. As important in the decision-making should have been how this appears both to our allies who have to plug the gap, and how it will be interpreted by those intent on doing us harm. It might have been fiscally expedient but it is as strategically inept as it is naïve.

A staunch Remainer but knowing politically the impossibility of formally reversing Brexit without terminating his own career, Starmer’s strong inclination nevertheless is to point Britain’s ship’s bows towards Europe. This only seems to have been reinforced by the election of Donald Trump and his proposal to impose tariffs on all imports into the US at a blanket 10% rate, except for China which is in line for a 60% levy. Starmer resents the protectionist US strategy.

While aligning with Europe, what seems to pass him by is that through the mechanism of the Customs Union the EU is itself an innately protectionist bloc. It is no stranger to the pre-emptive use of tariffs. Last month proves the point: as of 29 October, Brussels imposed import tariffs on Chinese electric vehicle-making companies ranging from 17% to 35.3% depending on the manufacturer’s ‘non-compliance’ (i.e. the extent to which its selling prices are subsidised by the Chinese government). All other non-compliant manufacturers will be subject to the 35.3% rate. Even Tesla does not escape after making a ‘substantiated request for an individual examination’ (i.e. a demand for a major steward’s inquiry from Elon Musk about being unfairly treated), an individual tariff has been set at 7.8%.

One of Trump’s beefs with the EU which his tariff is designed to combat is what he sees as unfair regulatory constraints being applied by the EU against US technology companies, especially when the USA still underwrites Europe’s defence (it’s a variation on the ‘I-pay-to-feed-you-and-you-still-eat-my-lunch’ principle familiar from his first term trade war). It remains unclear as to why Starmer thinks it is a clever policy actively to align himself with leaders such as Macron and Scholz, both of whom are either politically emasculated or in the case of Scholz likely also to be consigned to history in February’s election, while almost going out of his way to antagonise our closest national ally for no better reason than he finds Trump a disagreeable person. The UK is in the unique position of bridging Europe and the US on defence and, free of the Customs Union, can have acceptable trade terms with both.

As an aside, it is worth taking this opportunity to explode a myth that is increasingly being trotted out again in the context of trade and tariffs. We do not ‘trade with the EU’. The EU is not a country. British companies trade with customers and suppliers in the Netherlands, Germany, France, Italy etc under an EU-wide regulatory framework; but in the absence of fiscal union and there being as many different tax, social and employment regimes as there are country members which all compete with each other, trade goes where the best commercial opportunities are to be found, where quality goods and services can be bought and sold on the right terms with secure relationships, and not just simply because it is ‘the EU.’

An appreciation of rising risk

Tying all this together from an investment standpoint: UK funding costs as measured through government bond¹ yields² have continued to rise. US yields have been rising too and, to a lesser degree those in the eurozone. There are common factors such as Trump’s tariffs and how the rest of the world will reciprocate against him or negotiate with him. Investors are also weighing up national inflationary pressures which may be emerging: in Europe, the rising cost of wholesale gas which has more than doubled over six months and is now higher than it was a year ago; in the UK, the potentially inflationary effect of companies passing on the new National Insurance costs in higher selling prices, as well as that uplift in energy costs; in the US, the stimulus that is likely as Trump prepares to pump billions of dollars into the economy in a major programme of reconstruction. So far, markets have concluded that the inflationary risk is on the upside and that short-term interest rates may consequently reduce more slowly than they either wanted or previously anticipated. For the UK, adding to the underlying inflationary pressure is a weaker pound (more accurately it is the dollar which has appreciated 7% against a basket of currencies since late September), given the UK is a net importing economy.

But when under critical pressure Starmer breezily says, as he did this week, that the rising cost of mortgages has ‘nothing to do with the Budget’, its’ all ‘up to the banks’, he betrays two things: first, that as the official, quaintly titled First Lord of the Treasury he does not understand that mortgage lenders price fixed term products off mainly 2 and 5-year UK government bond yields, and the steeper rise in UK government bond yields than those in America and the eurozone is indeed reflective of market worries about the budget, the deficit and the rising debt. Second is a political paranoia: today the key 2-year government bond yield is higher than it was in the Truss/Kwarteng debacle following what was then undeniably a disastrous fiscal event; base interest rates currently at 4.75% might be three percentage points higher than they were in September 2022, but Starmer wants no unfavourable comparisons to be made between the very apparent deficiencies of Labour’s ‘Securonomics’ budget and that chaotic one of the Tories two years ago which so obviously directly claimed the twin scalps of its progenitors i.e. the prime minister and her chancellor.

This is no repeat of the dramas of the Tory era. These are more stable times politically. However, there are significant doubts about Labour: the lack of coherence of its policies; question marks over its fiscal competence; and what is becoming an established hallmark of this administration, that it says what it thinks any particular audience it is addressing wants to hear but when it comes to policy, acts very differently. It chips away at confidence and trust. Five months in, practice time is over; it really is time to get a grip, Sir Keir.

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

¹Government bonds are issued by governments.  Bonds are a type of fixed interest investment, in which a company, government or other institution borrows money and, in most cases, pays a fixed level of interest until the date when the loan is due to be repaid. 

²The rate of interest or income on an investment, usually expressed as a percentage.