A Budget Reaction

The immediate implication for markets from this Budget should be neutral. This has been reflected in the initial market reaction. Of course, often the devil is in detail that unfolds in the days after the Budget. For now, based on an initial quick analysis of the Budget Red Book, the focus is on the three issues outlined here: the fiscal numbers, the economic numbers and preparation for Brexit.

Fiscal activism underpinned by a resilient and sound economy was the main message of this Budget. In recent months it became clear the budget deficit had turned the corner and was on a credible improving trend. The Chancellor has taken advantage of this, not to pay down debt and achieve a balanced budget sooner, but rather to opt for what he called a balanced approach to the public finances. This means spending more, not raising net taxes and instead allowing the budget deficit to persist, albeit at low levels. This fiscal year the budget deficit is 1.2% of GDP and is projected to be 0.8% by 2023/24.

Despite this, the Budget was trying to be all things to all people, and heavily interventionist, with 86 new tax and spending measures.

The Budget confirmed a sizeable net £103.5 billion fiscal boost over the six fiscal years from 2018/19 to 2023/24. Of this, £98.5 billion was increased spending, the vast bulk being the previously announced boost to NHS spending. For four of the six fiscal years, net tax cuts were announced, and these will be particularly large next year at £4.2 billion, led by an increase in personal tax allowances.

The Chancellor stressed a “Double Deal Dividend” but was unable – probably because of the ongoing negotiations – to focus on saying whether there will be any Brexit Dividend. Brexit was the elephant in the room. Of course, it is not just Brexit, but what you do when you leave the EU that is key and that will help deliver this dividend.

I agree with the idea of a Deal Dividend in that once there is clarity about what lies ahead then this will trigger a rebound in investment. Uncertainty over the last two years is likely to have dented or delayed investment plans. The Double Deal, as the Chancellor called it, is that he is keeping back some fiscal firepower in case he needs to act and boost demand in the event of a No Deal.

The economy has suffered from a lack of demand. But it also needs a supply-side agenda and the Chancellor was right to acknowledge this. Given this, the economic and fiscal numbers were credible.

The good news is that the budget numbers are on an improving trend. As long as the market believes the projections are credible, and borrowing rates stay low, then the current economic environment provides a powerful dynamic in which the budget deficit can fall further, as it did post-war when public debt plummeted from 240 per cent of GDP. Last year’s debt of 85.2 per cent of GDP was a peacetime high and is projected today to fall to 74.1% by 2022/23.

Today’s Budget was partially aimed at showing that austerity is over. The trouble is, there is no clear definition of this, but you tend to know it when you see it. For many, it will mean an end of the squeeze on departmental budgets – and we will have to wait until next year’s Comprehensive Spending Review to see what will happen, particularly to the previously non-ring-fenced areas.

While I am an advocate of fiscal activism the reality is that the UK needs to save in good times to be able to spend in bad. It did not do this and the financial crisis blew the fiscal numbers off course. Not only did austerity restrain demand at a time when the economy needed it but also the government then missed the opportunity to borrow at record low rates to fund necessary infrastructure. Now, one could argue tax cuts should be high on the agenda, hence it is welcome that personal tax allowances are to be raised from next year.

Ending austerity should not mean unlimited public spending. There clearly needs to be ongoing reform, including regional wage policies. Ending austerity should not mean keeping taxes high to fund spending. It also does not mean sacrificing capital spending to fund current expenditure. Thankfully, the Budget showed both a desire to avoid further tax hikes, an aim for cuts, and to protect capital spending plans.

It is important to appreciate that the margin of error on these one year ahead fiscal numbers is huge. Thus, we should resist the temptation to aggregate forecast changes over the next five years, as it makes little sense to do so. The key is what happens to growth.

The trouble is that the UK’S economic picture is one of low growth, low inflation and, presumably, low interest rates. The UK’s trend rate of growth has previously been revised down since the global financial crisis. Today the growth forecast for this year was tweaked lower by the independent Office for Budget Responsibility (OBR) to 1.3%, and higher from 1.3% to 1.6% for next year, and averaging around 1.5% up to 2023.

This leaves the UK vulnerable to any global setback. Vital is what happens to productivity growth and this would be boosted by increased investment and innovation – and it is helpful there were incentives to try and boost these. I would not be surprised if UK growth in 2019 is higher than expected: as consumption could be boosted by rising wages, higher employment and the announcement of an increase in personal allowances from next spring, while a Brexit deal would likely boost investment.

The most striking aspect is that the OBR projects a further 800,000 jobs by 2023, bringing to 4.2 million the net number of new jobs since 2010.

What about a no deal? Clearly we want to avoid a no deal, but a valid question is that the implied threat on the eve of the Budget that if there was no deal then the Chancellor would have to take action to make Britain universally competitive – including cutting taxes and easing the regulatory burden on firms, as well as to use fiscal policy to provide support to the economy – was a bizarre one.

It must surely have been aimed at our EU neighbours, to encourage them to reach a deal. Of course, the Chancellor is constrained from pushing this, while the negotiations are ongoing, but it should highlight that the UK should be in a better position once it can determine its own post-Brexit destiny. And we saw elements of that today.

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