Fall in inflation eases pressure on Chancellor

Chancellor’s first Budget comes against backdrop of falling inflation and lower predicted borrowing costs

Jeremy Hunt will deliver his maiden Budget today against a backdrop of falling global inflation and lower predicted borrowing costs as pressure grows for him to abandon a tax raid. The Chancellor will pledge to deliver “sustainable growth” a day after figures showed US inflation fell last month. Price rises fell from an annual rate of 6.4 per cent in January to 6 per cent in February, cementing bets the Federal Reserve will not have to step up the pace of rate increases.

JEREMY HUNT will deliver his maiden Budget today against a backdrop of falling global inflation and lower predicted borrowing costs as pressure grows for him to abandon a tax raid.

The Chancellor will pledge to deliver “long-term, sustainable growth” a day after official figures showed US inflation fell last month, in a boost for hopes that a downturn in developed economies can be avoided.

Data showed price rises falling from an annual rate of 6.4pc in January to 6pc in February, cementing bets that the Federal Reserve will not have to step up the pace of rate increases to keep a lid on prices. Lower US borrowing costs are likely to bring down the peak for interest rates across the Western world.

Stock markets climbed and the dollar weakened against other currencies as traders also wagered that the worst of the turmoil was over following the collapse of Silicon Valley Bank (SVB).

The FTSE 100 closed up more than 1pc, while the S&P 500 rose almost 2pc amid a recovery in bank stocks a day after some smaller US lenders lost more than half their market value.

The picture suggests an increasingly benign economic environment for Mr Hunt’s Budget, but he is still expected to press ahead with an increase in corporation tax and other measures intended to steady the public finances despite resistance from senior Tories.

Sources suggested that the Chancellor does not intend to change course even though the Office for Budget Responsibility (OBR), the Government’s spending watchdog, is likely to row back on bleak forecasts it presented last year in the wake of the mini-budget.

Mr Hunt will be helped by favourable interest rate and UK gilt yields projections used by the OBR to compile its forecasts. The predictions are based on rates in the immediate aftermath of the Bank of England’s latest meeting, where Governor Andrew Bailey signalled policymakers would not lift borrowing costs much higher than the current rate of 4pc.

Traders are currently betting that the Bank will raise interest rates one more time before pausing. A week ago, financial markets priced in a peak of as much as 4.75pc this year.

A widely expected move to keep typical energy bills capped at £2,500 for an extra three months will also bring the headline inflation rate down towards the Bank’s 2pc target more rapidly.

A drop in rate rise expectations over the past week could make mortgages cheaper. Swaps – which are used to price fixed-rate mortgage deals because they factor in bets on future UK interest rate moves – have fallen as investors bet on slower rate rises.

Last Friday two and five-year swaps were priced at 4.57pc and 4.04pc respectively. Yesterday these had fallen to 4.28pc and 3.88pc. If the lower twoyear swap rate is sustained and translates directly into a drop in mortgage costs, this would save the average borrower £50 a month in interest payments on a typical £200,000 loan.

Aaron Strutt, of Trinity Financial, a mortgage broker, said: “Lenders know they will have to work harder to attract borrowers so when they get the chance to lower their rates, they will.”

The collapse of SVB rocked global financial markets and prompted investors to reevaluate predictions that global interest rates would head much higher to control inflation owing to fears of global contagion.

US officials raced last weekend to guarantee deposits and restore public confidence following the failures. The UK division of SVB was bought by HSBC for £1.

Panic over the financial system eased yesterday, with some of the lenders hit hardest by the sell-off a day earlier regaining a significant portion of their losses. Shares in First Republic Bank surged by 61pc at the opening bell yesterday after declining as much as 70pc on Monday. Pacwest Bancorp jumped 54pc and Western Alliance climbed 42pc.

‘Americans can rest assured that our banking system is safe. Your deposits are safe.” As guarantees go, they don’t come much better than a personal one from the US president – delivered from the White House lectern too, for added punch. Yet the concern for Joe Biden is that his words, in the aftermath of the collapse of several US banks, not just Silicon Valley Bank (SVB), took a while to sink in.

Despite such reassurances, global bank shares continued to slide for a third day, with the panic spreading to Asia, pummelling regional financial lenders and share indices, before markets eventually staged a strong rally. Nevertheless, $465bn (£382bn) were wiped off financial stocks in the previous two days, Bloomberg calculated.

The worst of the rout was concentrated in US regional bank shares. San Francisco-based First Republic lost 62pc of its value, Arizonaheadquartered Western Alliance Bancorp fell 47pc and Cleveland’s Keycorp dropped 27pc on Monday. First Republic and Western Alliance are also among six provincial lenders that have been downgraded by the ratings agency Moody’s.

In one sense, this focus on a specific corner of the banking industry is reassuring because it suggests investors for the most part understand what the problem is. The unravelling of SVB has shone the light back on a whole tier of mid-ranking but still sizable US banks that had more or less completely slipped off the radar.

It is an oversight that must be laid squarely at the door of Donald Trump, and has potentially serious implications for the Chancellor’s attempts to roll back financial services regulation in Britain through the so-called Edinburgh Reforms. In 2018, Trump, the then-us president, signed a new law called the Economic Growth, Regulatory Relief, and Consumer Protection Act, but it may have just as easily been called the Rainbows, Unicorns and Fairies Act because the idea that you could have all three of those things at the same time is for the birds.

Yet despite the giant red flag of a name, the law was passed anyway, paving the way for widespread relaxation of rules that had been introduced in the shadow of the financial crisis to prevent a repeat of excessive risk-taking.

The argument at the time was that many of the provisions found in the Dodd-frank Act amounted to a one-size-fits-all approach. Regional lenders insisted that they should not be the focus of the same level of supervision because they were not systemically important. They also claimed that the over-burdensome regulations would make it harder for them to provide a genuine alternative to the titans of American banking such as Bank of America and Jpmorgan.

The changes lifted the threshold at which banks are subject to stricter oversight from $50bn to $250bn, allowing Silicon Valley Bank – with $209bn in assets at the end of 2022 – to slip through the net.

It meant a whole second and third tier of banks escaped the Federal Reserve’s annual “stress tests”, and other financial safety requirements – a move that some lenders may have interpreted as carte blanche to do as they please.

SVB shareholders have accused the bank’s boss Greg Becker and its finance chief Daniel Beck of concealing how rising interest rates would affect the bank.

Nevertheless, a more alert regulator should have been able to spot some of the risks quite easily. Deposits grew rapidly and 96pc of those were not covered by the federal insurance policy. The bank then made a massive bet on long-term fixed-rate bonds, which left SVB hugely vulnerable to a sudden swing in interest rates.

It also became hugely reliant on the Federal Home Loan Bank system for funding, which suggests it was struggling to access more mainstream sources of financing. Perhaps most alarmingly, SVB also had no risk officer for most of 2022.

The warning signs were everywhere and the failure to spot them raises the question of what else has fallen through the cracks, hence the breadth of the market sell-off. At times, the light-touch regime that Trump’s repeals ushered in appears to have basically meant there was no oversight at all for smaller banks.

The British Government will probably baulk at the suggestion that its proposed Big Bang 2 reforms are comparable to Trump’s sweeping reforms of Dodd-frank because Jeremy Hunt wants to do away with rules that were set up for European insurers and perhaps were never really suitable for their UK counterparts.

But the idea that removing red tape will boost growth is still broadly the same and it too comes with risks. If the Treasury wants to make it easier for insurers to invest in private equity, property and infrastructure, then it has to accept that there is a trade-off. It will mean that capital is trapped in long-term illiquid assets that are difficult to access in the event that the industry finds itself facing a flurry of big payouts – essentially what happened with SVB.

This is no surprise. Those in power always seem to get regulation the wrong way round, choosing a procyclical approach when what is really needed is countercyclical policy.

We overshackled the banks after the crisis when what was really needed was some exuberance and risk-taking to turbocharge the world economy out of its post-bailout slump.

Then somebody decides that the rules are too onerous just in time for the next crisis. How easily the mistakes of last time appear to have been forgotten.

‘It may have easily been called the Rainbows, Unicorns and Fairies Act’