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  • Writer's pictureJuszt Capital

Truss a little magic to carpet over the cracks

Updated: Nov 17, 2022


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Real Estate, Interest Rates, Inflation & Bonds
Truss a little magic to carpet over the cracks

"will the latest stamp duty cuts help first time buyers"

The Chancellor of the Exchequer, Kwasi Kwarteng announced on Friday 23rd September buyers in England and Northern Ireland will pay no stamp duty on the first £250,000 of a property’s value — double the previous £125,000 threshold — and first-time buyers will pay no tax on the first £425,000, up from £300,000.

"golden gilts lose their shine"

First-time buyers in London and the south-east could potentially save as much as £11,250 under the new measures, according to the government. Non-first-time buyers purchasing a house for £312,000 — the average price of a home in England according to the Land Registry — would save around £2,500, according to official estimates.

The measures will do little to insulate these very purchasers the chancellor is looking to give a leg up too, from the effects of rising interest rates.

Those ambitious FTB's wanting to push their purchasing budget, to take advantage of the higher cap rate, need to balance their property dream with the higher rate monthly repayments.

Kwarteng laid out plans to cut the property transaction tax as part of his growth-focused fiscal package on Friday. The move is designed to give a leg up to first-time buyers and support an increasingly fragile housing market.

The cut, which could save some buyers more than £10,000, would “support growth, increase confidence and help families aspiring to own their own home”, said Kwarteng.


But these savings could be dwarfed by higher borrowing costs if the Bank of England seeks to offset the inflationary impact of the government’s tax cuts by raising interest rates.

Why has the Bank of England raised their interest rates?

Russia’s invasion of Ukraine has led to higher energy bills and increases in the prices of food and other goods. The Bank of England need to keep inflation is low and stable, so they need to bring inflation back down by increasing interest rates.

How long will high inflation last?

Higher energy prices are the main reason why inflation is currently so high. Russia’s invasion of Ukraine led to big increases in the price of gas. The war in Ukraine has also increased food prices.

There is also pressure on prices from developments in the UK. Businesses are charging more for their goods and services because of the higher costs they face. There are more job vacancies than there are people to fill them, as fewer people are seeking work following the pandemic. That means that employers are having to offer higher wages to attract job applicants.

Why has the Bank of England stepped in to buy £65Bn Gilts with maturities of 20 years or more?

The Government cap on energy bills means that we expect inflation to rise only a bit further from where it is now. The rate of inflation is currently about 10%. We expect it to rise to about 11% in October. After that, we think it will stay above 10% for a few months, before starting to fall.

With inflation and interest rates rising the haven of Governments bonds (Guilts) has taken a battering.

This move, a result of the sizeable fall in the price of these government bonds, called 'gilts' is a fall enhanced by 'ad-hoc' mini budget. The subsequent liquidity crisis e.g., Liability Driven Investment funds, with a gross value of around £1.5 trillion, of which a staggering £1 trillion has been invested in gilts and other bonds are largely leveraged funds. When they buy gilts, they frequently use them as collateral to raise cash (known as the 'Repo' market), then use the cash to buy more gilts, pledge the gilts again and buy more gilts, and so on and so forth.

The risk of raising money in this way is that when the value of that collateral collapses, which it has done with the crash in gilt prices, the funds must somehow find cash either to repay the money they've borrowed or pledge more collateral.

Haven't we seen these models before, in the U.S., with the Lehman’s crash, and subsequent bank bailouts, in 2008, due to collateralised debt obligations (CDO's), poorly rated by the credit agencies credit default swaps?? We do know a lucky few shorted the housing market through credit default swaps (CDS's) and made a killing. We are learning from our mistakes, right??

The current concern for the taxpayer is the Chancellor has indemnified the Bank of England to any losses incurred by the £65Bn ballot in the bonds market. Guess who'll be fitting the bill... the UK Government and hence the taxpayer. The chaos in the gilts market is having profound effects on other sectors. Who are the biggest buyers on the gills market - the UK pension funds.

The British pension funds with big losses in gilt market derivatives have sought emergency funds from the companies they manage money for, as they race to dump assets to raise cash. It's the Pension Funds being caught out that has led to the Bank of England steeping in to shore up the gilts market.

The extent of the liquidity squeeze on pension funds remained unclear after the Bank of England said it would buy 65 billion pounds ($72.21 billion) of gilts and postponed plans to sell bonds it already holds. One pension fund manager, who spoke on the condition of anonymity, said his scheme had requested its parent open a credit line on Wednesday when it looked like it was running out of cash but was refused. The BoE then made its announcement, sending bond yields lower and easing the panic.

The Bank of England accepts that all it is doing is managing the transition to lower gilt prices, and higher yields (or interest rates on government bonds), in an orderly way. And it accepts that gilt prices may ultimately fall back to those lower levels. Which means that it will be incurring losses on the £65bn of bonds it has committed to buy. Except the losses won't be the Bank's losses, as mentioned earlier.

The paradox to all this is that whilst the pension funds could have collapsed, because of a shortage of cash or liquidity, the Bank of England bailout, at some cost to taxpayers, means the pension funds should emerge stronger.

Some economists are suggesting mortgage rates of more than 6 per cent were now a distinct possibility, a development that would leave house prices more overvalued than in 2007 and could lead to a significant correction.

The stamp duty cut is small beer in the face of those forces.

However, previous stamp duty cuts have driven up property values because sellers add the theoretical saving on to house prices. The government’s stamp duty holiday in 2020 is regarded by property analysts as one of the reasons behind rapid house price growth in the two years since.

There has been a lot of adjustments with stamp duty land tax over the last decade with one regular outcome, buyers pay for cuts and sellers pay for rises through market adjustments. Property experts said the measures would do little to insulate buyers from the effects of rising interest rates or meaningfully boost first-time buyer numbers.

However, the cut may entice investors to target properties valued up to £250,000.

The measures are likely to have a neutral effect on the exchequer’s stamp duty tax receipts because 90 per cent come from properties valued at £250,000 or more, and prices are still rising. The Treasury received a record £17.5bn from stamp duty in the 12 months to August this year.

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