Time to short the Union Jack? Investors bet the U.K.’s Build Back Better plan is doomed

October 15, 2021, 4:35 PM UTC

Supermarket shelves are bare. Soldiers have been deployed to bring fuel to petrol stations as a trucker shortage and panic buying fray the country’s nerves. At sea, tanker ships cannot get into ports. Eyeing the chaos, currency traders short the pound. They’re betting the government is powerless to restore order and that the Bank of England’s plan to hike interest rates next month to stave off runaway inflation will backfire.

Welcome to Britain, not even a full year into the post-Brexit era.

The pandemic has left Britain’s economy with much deeper scars than its neighbors’—the very same ones it so recently divorced. Now analysts and short-sellers are betting that Prime Minister Boris Johnson’s ambitious infrastructure and safety net program, Build Back Better, will collapse under its own weight, handicapped by high inflation, blooming debt, and weak economic growth.

For the markets, this just isn’t a great time to be Britain.

Investors continue to keep their distance. For the second straight year, London’s FTSE 100 index of the biggest U.K. companies is underperforming the S&P 500 as well as most European bourses. Further abroad, the Indian equity market looks poised to overtake the FTSE this year as global investors see more growth potential in Narendra Modi’s India than in Johnson’s Britain.

Build back slower

When Johnson spoke at the Conservative Party’s annual conference on Oct. 6, he avoided topics like skyrocketing energy prices and the supply-chain mess.

He instead promised to fix the “biggest underlying issues of our economy and society” that “no other government has had the guts to tackle before”: immigration. When the topic of Britain’s chaotic markets did come up, the leader of “the government that got Brexit done,” as Johnson calls it, was quick to place much of the blame on business and to describe the shortages as the natural byproduct of “growth and economic revival.”

But despite the upbeat rhetoric, Johnson’s government faces an unfortunate fact: The U.K.’s economy isn’t growing at the rate they want. August GDP figures rose only by 0.4%, which means overall third-quarter GDP growth will likely come in at half of the Bank of England’s 3% forecast. The economy is still 5% smaller than it would have been if growth had continued on its 2010 to 2019 pre-pandemic trajectory; in contrast, the U.S. had nearly closed that gap by the second quarter of 2021, albeit by amassing a spectacular amount of debt.

Now, even though economic growth is sluggish, the Johnson government and the central bank are looking to policy-tightening and welfare cuts that some analysts argue will only further damage the economy and handicap growth.

Rushing to the exit

While COVID-19 is far from vanquished in the U.K.—the country boasts the highest case rate in Western Europe—Johnson’s government has largely moved on to address other issues.

Chancellor of the Exchequer Rishi Sunak is raising taxes and cutting spending to control the budget deficit. At the same time, the markets are pricing in a BOE rate hike in December—the first since the start of COVID-19. And in another step to rein in spending, the government is on course to cut stimulus payments as well.

Now analysts fear that Sunak’s move to end the U.K. furlough program—a COVID-19 support package that kept laid-off workers on company payrolls throughout the pandemic—as well as to cut universal credit benefits, or social security payments, by £20 ($27.50) a week, will hit consumer confidence just when the country needs consumers to spend.

Matthew Lesh, head of research at the Adam Smith Institute, a free-market think tank, wrote Johnson’s policies were “hamstringing the labor market, raising taxes on a fragile recovery, and shying away from meaningful planning reform.”  

These changes—the tightening of fiscal policy by Johnson’s government, combined with rising energy prices—will disproportionately impact lower-income workers, says ING chief economist James Smith. And while some analysts predict the high savings rate accrued over the pandemic will act as a buffer against these consumer headwinds—U.K. households amassed 8% of the GDP over the pandemic, according to Morgan Stanley—high-income earners saved more and “it is not going to be unleashed on the economy straightaway,” Smith says.

Not all analysts see it that way. Kallum Pickering, economist at Berenberg Bank, says that “tightened policy makes sense, because you have a very severe short-term inflation problem driven by a combination of exceptionally strong demand, and global supply-chain issues.”

Pound drop

Complicating the U.K.’s already difficult situation, however, currency traders are losing faith in economic growth and the Bank of England’s policy route. Britain’s pound sterling is at the lowest level against the dollar it has been this year.

Bank of America strategists say high inflation and low growth is hitting the U.K. harder than most countries, and any strength in the pound is an opportunity to sell. Analysts note that the price drop in pound sterling is “what seems to be a ‘light bulb’ moment that Brexit actually matters” coming after people had “taken a rather blasé approach following the signing of the deal.”

In the markets, the FTSE 100 index of the biggest U.K. companies has just hit a pandemic high, up 10% for the year, but still lags behind the S&P 500, which is up 19%, as well as major bourses in the EU.

These troubling signs illuminate the U.K.’s sudden rush of panic buying, which according to Pickering at Berenberg reflects a lack of confidence by the public in the government’s ability to manage the economy.

Still, he is optimistic that the rocky recovery will pass. “This proclivity to overreact to what are garden variety risks in an economy which is fundamentally sound…” said Pickering. “It’s just a bad habit.”

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