The past few weeks in the U.K. financial markets have been extraordinary. The risk premium placed on the issuance of public and private debt has roiled both domestic and global financial markets.
The demise of the Truss government and the prospect of a new prime minister have stabilized the pound and pushed down long-dated yields on gilts.
The demise of the Truss government and the prospect of a new prime minister with a more fiscally conservative agenda have stabilized the pound and resulted in noticeable declines in long-dated yields on gilts.
While the risk of further financial instability has not completely receded, financial conditions have eased somewhat, even as they continue to be a dead weight on growth prospects.
U.K. financial markets continue to price higher levels of risk into the value of holding securities but appear on the verge of turning the corner after recent political developments.
But that’s not to say conditions are back to normal. The equity markets are still under water, there is more than the usual amount of risk priced into the money markets that finance commercial activity, and corporate bond spreads are signaling concern for growth.
While volatility in the currency market has eased a bit and the pound appears to be looking for direction, the yearlong downtrend in the pound’s value has yet to be broken.
All in all, the composite RSM UK Financial Conditions Index continues to show the tightening effects of monetary policy in response to soaring inflation and the energy crisis.
In RSM’s index, a value of zero signifies normal levels of risk and volatility. Values above zero indicate an accommodative climate for investment necessary for growth. Values below zero indicate an inordinate amount of risk priced into securities and a lower propensity to borrow or lend. Such negative values lead to diminished economic activity.
With the change in government, and particularly with the actions of the Bank of England and the Exchequer, the Index has eased to minus-1.1 standard deviations.
That indicates still-tight financial conditions but an improvement from the minus-1.7 reading of four weeks ago at the unveiling of the Truss government’s budget plans.
We expect the Bank of England to maintain increases in the cost of credit even as soaring prices of food and energy cause households to shift their spending patterns.
With the financial markets supplying the guardrails, we expect the fiscal authorities to rethink budget priorities.