Could a UK Fiscal Crisis Trigger Government Collapse? | Merryn Talks Money

Understanding Fiscal Events

• 🚨 A fiscal event is defined by the gilt market becoming highly concerned, leading to a rapid rise in gilt yields, as seen during the Liz Truss crisis in 2022 when yields rose by 1% in four days.
• ⚠️ The UK has experienced three smaller "mini fiscal events" since the current government took power, with gilt yields increasing by 20 basis points (0.2%) on each occasion due to market concerns about growth outlook and increased government debt issuance.

The UK's Worsening Fiscal Position

• 📊 Public sector net borrowing in August was £18 billion, a 40% overshoot of the OBR forecast, and for the first five months of the year, the deficit has exceeded projections by £16 billion.
• 📈 If this run rate continues, the annual deficit could reach approximately £190 billion, significantly higher than the OBR's forecast of £120 billion, and potentially mirroring last year's £150 billion deficit plus an additional £40 billion overshoot.
• 📉 The OBR's forecast for deficit reduction relies on increased capital tax receipts, lower debt interest payments, and reduced welfare spending, but current conditions make these unlikely, with slowing growth already impacting VAT receipts.

Potential Triggers for a Crisis

• 📉 A scenario where the UK deficit continues on its current trajectory, leading to increased gilt issuance, could cause gilt yields to rise sharply due to supply and demand dynamics, creating a vicious spiral of higher funding costs and increased deficits.
• 🏦 If gilt yields rise significantly (e.g., 30-year yields reaching 6.12%), the Bank of England would likely intervene to ensure financial stability, similar to the Truss crisis, by initiating a quantitative easing program and buying gilts.
• 🏛️ Such intervention would likely come with stringent conditions for fiscal restraint from the government, potentially requiring an emergency budget to halve the deficit, which could be politically impossible for the current government to pass, leading to a constitutional crisis and a general election.

Market Reactions and Investment Opportunities

• 📉 In a fiscal and constitutional crisis scenario, the UK equity market would likely see significant downturns, with domestically exposed companies (like UK real estate) falling sharply, while internationally earning companies might fare slightly better but still decline.
• 💡 Historically, market crises eventually pass, and periods of significant market stress can present profound investment opportunities for those with the courage and liquidity to buy during the downturn.
• 💰 Holding a bit more cash and potentially gold could be prudent strategies for investors concerned about such an outcome, as it provides liquidity to capitalize on emerging opportunities.