27 Mar Hunt’s eye-catching initiatives might be anything but eye-catching right now
First an apology for the length of this update. The budget in the UK has had to share the limelight with US banking casualties and the near collapse of a Swiss banking behemoth, so this newsletter aims to consider all these issues, but we hope you will find it helpful.
One could naturally be forgiven if the reaction to Jeremy Hunt’s first spring budget was ‘so what’? After all, investors were already reeling to some degree from the Chair of the Federal Reserve, Jerome Powell’s comments to the Senate Banking Committee a week before, and it is easy to see why. Rather than mollifying tones, the Fed Chair suggested rate increases might actually accelerate, and the terminal rate be higher than markets were pricing in, providing a reality check for investors.
Then along came Silicon Valley Bank (SVB), closely followed by Signature Bank and, all of a sudden, investors were starting to feel less concerned about whether ISA allowances should go up, and more worried about a full-scale banking crisis. For the record, we do not see a repeat of 2008-09 but we will consider what is going on in the banking sector more fully towards the end of this publication.
The Spring Budget was billed as a set of growth initiatives by the Chancellor with a focus on getting the UK back to work. Not that the UK necessarily has an unemployment problem, but more of a rethinking of attitudes towards work in a post-covid world. However, blaming the problem of firms struggling to find workers on some great covid mass-resignation is only part of the story in our opinion. This is as much a post-Brexit legacy, where migrant workers have simply chosen to return home, or moved elsewhere, and the UK has struggled to fill the void.
The severity of the UK’s economic circumstances was highlighted by the Office for Budget Responsibility (OBR) warning that the country’s borrowing is running at unsustainably high levels, requiring less spending, more taxation, or both to rectify the situation. Against this backdrop, the main focus for Jeremy Hunt was on improving pension allowances and better access to childcare.
In essence it was a steady budget that didn’t rock the boat too much but contained one or two golden nuggets. The key points worth noting from the announcement are as follows:
While Mr Hunt was keen to put as much distance as possible between this budget and Kwasi Kwarteng’s disastrous mini-budget last September, he still needed to uphold a commitment to Liz Truss’s watchword, growth, which is one of the Prime Minister’s five key priorities. If OBR projections prove accurate then the UK is set to avoid recession in 2023, and there will also be a significant reduction in inflation down to 2.9% by the end of the year, both of which would be welcomed by financial markets.
Mr Hunt said this would be a budget for ‘long-term, sustainable, healthy growth’, and it will deliver ‘prosperity with a purpose’. The OBR expects inflation, which was at 10.7% at the end of last year, to be 2.9% by the end of 2023, meeting Rishi Sunak’s target of halving it. Without wishing to pour cold water on this, inflation was very likely to fall away quite quickly in 2023 anyway as the baseline comparator shifts.
Since the autumn statement, the OBR, along with many other forecasters, has become slightly less gloomy about the prospects for 2023. It is now expecting GDP to contract by 0.2%, instead of the 1.4% it predicted in November. The Chancellor said that will be followed by growth of 1.8% next year, 2.5% in 2025 and 2.1% in 2026. That compares with November forecasts of 1.3% for 2024, 2.6% for 2025 and 2.7% for the year after. In summary, the OBR expects stronger growth in the next two years, but a slower recovery after that.
The Chancellor asserted that by the end of the forecast period, the government’s current budget deficit (the day-to-day spending minus tax revenues), will be in surplus. He has something of the wind in his sails here as surprisingly robust tax revenues actually provided some fiscal headroom ahead of the speech.
He said the OBR is expecting him to meet his fiscal rule of keeping public sector net borrowing below 3% of GDP, with £39.2bn to spare, by the end of the forecast.
Public sector net debt was previously forecast to peak at 97.6% of GDP in 2025-26, falling to 97.3% two years later. It is now expected to hit a lower peak of 97.3%, falling to 94.6% by 2027-28. Still enormous numbers, it must be said.
As in the autumn statement, he said day-to-day spending will rise by 1% a year in real terms from next year to the end of the forecast period.
The energy price cap guarantee will remain at £2,500 for the next 3 months. It had been due to rise to £3,000 in April but will now be delayed until July 2023. Of note, wholesale energy prices have dropped by around 50% since October 2022.
A planned increase of 11p in fuel duty this year has been cancelled, meaning the 5p cut introduced in the Spring Budget 2022 remains in place for the next 12 months. According to the Spectator, this will save the average motorist £100.
The starting rate for savings income will be frozen at £5,000 for the 2023/24 tax year. It will then increase in line with the CPI measure of inflation thereafter. Also, annual ISA limits will remain at £20,000 for 2023/24, and again, this will increase in line with CPI after that tax year.
There will be changes to the Capital Gains Tax pages within tax returns. These will now require individuals and trusts to report on the disposals of crypto-assets separately through a new standalone crypto-assets section.
Some pretty major initiatives here to a) encourage people back to work and b) encourage workers to make provision for their own retirement.
The Pension Annual Tax-free Allowance will increase from £40,000 to £60,000 from April 2024. If an individual’s income exceeds £260,000 then the annual savings allowance is tapered. Maximising the increased annual allowance allows savers to shelter either a more substantial slice of disposal income, or more capital that can be locked away in a pension.
Where someone has already accessed their pension pot, the annual savings allowance, known as the Money Purchase Annual Allowance, will increase from £4,000 to £10,000.
The Pension Lifetime Allowance which currently stands at £1.07m will be abolished. However, the maximum amount someone can withdraw from their pension tax free, will be frozen at £268,275. For context, that’s equivalent to 25% of the current lifetime allowance. Withdrawing money above this amount will be taxed at the pension holder’s marginal rate. In other words, whilst people can save more into a pension, the tax paid is effectively deferred and will be charged at a later date when withdrawn.
Business taxes and reliefs
The headline rate of corporation tax will still rise to 25% (as previously announced). Back bench disquiet over the policy, meant there were rumours it could be scrapped but the Chancellor pointed to only 10% of companies being likely pay the full 25% tariff.
- Small company rate 19%
- Marginal rate (£50-£250k profits) 20-24%
- Full rate (more than £250k profits) 25%
Whilst the super deduction comes to an end from 31 March 2023, it will be replaced by full capital expensing for the next 3 years. This comes at an estimated cost of £9bn to the Treasury and the aim is to make it permanent in legislation, where feasible. This policy means businesses can deduct 100% of their spending on investment in qualifying brand new IT equipment and plant and machinery from taxable profits right away, as opposed to over several years. The assets must be new, and the legislation excludes leases and cars. If investing in used assets, then the annual investment allowance threshold of £1m applies. The legislation comes into effect from 1 April 2023 and is set to end on 31 March 2026. Most SME businesses won’t spend more than £1m on capital assets so this is likely to only benefit a select few organisations.
The government also introduced a 50% first-year allowance meaning businesses can now deduct 50% of the cost of certain other plant and machinery, referred to as special rate assets, from profits in the first year of purchase.
A new 27% credit is being made available from 1 April 2023 if an SME business is loss-making and incurs at least 40% of total expenditure on research & development (R&D) activities. If qualifying expenditure doesn’t reach that amount, then a new 10% credit applies instead (as already announced in the Autumn).
The introduction of restrictions based on overseas sub-contractors, and non-UK payroll externally provided workers, which was announced in the Autumn Statement of 2022, will now be delayed by a year and won’t come into force until 1 April 2024.
If parents have children under the age of 3, and they are in work, they can benefit from 30 hours of free childcare for each of their children over the age of 9 months. The Chancellor claimed that this will reduce childcare costs by 60% and entice more parents back into work. The introduction of this policy is being staged for children of higher ages due to the limited availability of childcare places in nurseries in the UK. That might be of concern to many parents and could impact on their ability to return to work. According to MoneyWeek only 57% of local authorities have enough childcare places available for children under two, down from 72% in 2021.
The phasing will work as follows:
- From April 2024, working parents of 2-year-olds will be able to access 15 hours of free childcare.
- From September 2024, working parents of 9 month to 2-year-olds will be able to access 15 hours of free childcare.
- From September 2025, working parents of 9 month to 2-year-olds will be able to access 30 hours of free childcare.
Also, more funding will be made available for schools to provide wraparound care for school-age children. There will be incentive payments of £600 for childminders who join the profession. Finally, there will be an increase in the funding to nurseries of £204 million from this September, increasing to £288 million next year.
Alcohol duty will remain frozen until August 2023, and then increase in line with RPI. For the hospitality industry, ‘draught relief’ will increase from 5% to 9.2% on qualifying beer and cider, and 20% to 23% on qualifying wine, spirits and other fermented products.
There will be 12 new investment zones receiving £80m of support and covering the following areas:
- West Midlands
- Greater Manchester
- Northern Ireland
There will be £400m for new levelling up partnerships, plus £161m in Mayoral authorities and Greater London. A further £200m is being allocated to regeneration projects in England.
The ability to open ‘Help to Save’ accounts has been extended until March 2025. It was previously due to close from September 2023. The Mortgage Guarantee Scheme has also been extended until 31 December 2023, which means an extension of the availability of 95% loan to value mortgages.
Despite some noteworthy features contained in the budget, with so much uncertainty about the direction of interest rates and the malaise in the banking sector, it is hard to truly isolate what investors thought of Mr Hunt’s measures. The FTSE100 is largely unchanged, UK bond yields fell slightly, though are heavily down over the month (meaning prices have gone up) and the pound has actually risen modestly.
Budgets aside, all eyes around the world remain locked on the US economy and the Federal Reserve. Whilst the inflation picture is undoubtedly improving, the economy remains surprisingly robust, and this is giving policy makers something of a headache. Of concern is the jobs market, the most watched piece of economic data on the planet. In essence there have been too many job openings and insufficient people from the working population to fill them. But digging underneath the surface reveals some cause for optimism. The labour participation rate has risen to 62.5%, the highest since covid, meaning the pool of workers has grown. Moreover, growth in higher-paying sectors is slowing with job creation being driven by industries where salaries are generally lower, evidence that some sectors like hospitality and leisure are still adding back positions lost to the pandemic.
Whilst the rhetoric from the Fed points to higher rates and possibly for longer, it faces a potential credibility issue. In recent months the central bank had appeared to soften its tone and moved to rate hikes of 25 basis points, a strategy that is entirely sensible, as it allows breathing space to assess the efficacy of rate rises made so far. A sharp about-turn, reverting to more aggressive tightening, sends a message to markets that the Fed might be panicking and that is not what investors want to hear. As it turns out SVB and Signature Bank might end up forcing the Fed into a complete climb-down, meaning this week’s monetary policy meeting ends with rates left on hold. Which is probably the right moment to consider what is happening in the banking sector.
Normally when interest rates rise, it tends to be good news for banks as it helps their margins. But at the moment, we have what is called yield curve inversion. This is not that unusual. Normally if you invest in a long-dated bond, you will enjoy a better yield than on a short dated one because you need to be compensated for the additional risk. Simplistically it looks like this:
During yield curve inversion this reverses, and short-dated bond holders get the higher yield. This is the bond market’s way of pricing in an economic slowdown, or a recession. The bond market is essentially saying it expects higher rates in the short term, but rate reductions further down the line to help the economy recover. Graphically it is the alter-ego of the normal shape:
This causes banks a problem because they tend to borrow short term but lend longer term, meaning their margins come under pressure. Most well-run and adequately capitalised banks can cope with this, but some niche banks can be more vulnerable. SVB is the 16th largest bank in the US but 93% of their deposits are from corporations and half of these are early-stage technologies, which tend to be capital-hungry. If access to borrowing dries up for these companies, their next call is to go to the bank and withdraw their own capital. SVB (and Signature Bank for that matter) was vulnerable to capital flight.
Most banks, and the two in question are not unusual in this respect, park capital in the bond market but as we know from personal experience, bonds in general had a really bad year in 2022. So, when clients of SVB clambered to get their hands on some of their money, SVB had to sell some of their badly hit bond book to meet the cash demands of their depositors. On 8th March SVB triggered a $1.8bn loss by doing this, which under ‘mark to market’ rules, had to be provisioned for and this did not go unnoticed by markets. Nor indeed other depositors. The regulator stepped in and shut down SVP two days later.
In order to maintain confidence, the Federal Reserve, the US Treasury and the Federal Deposit Insurance Corporation (FDIC) have instigated two policies:
- All SVB and Signature Bank depositors will be repaid in full.
- A Bank Term Funding Programme was established to allow banks to deposit their bonds at par, not prevailing market value, providing collateral and access to capital, without having to realise losses on their bond assets.
Combined, these measures represent a ring-fence around the issue, but it is probably too early to say how successful this will be. Attention appeared to shift this weekend to the rescue-takeover by UBS of Swiss counterpart, Credit Suisse (CS). This represents a sorry end for a once grand institution, with the exit price for CS shareholders a whopping 99% lower than its peak in 2007. But spare a thought for holders of Additional Tier 1 (AT1) bonds, who have been completely wiped out. This represents roughly $17bn of assets that are now worthless.
Normally in the winding up of a company, shareholders rank below bondholders but with CS equity holders at least appear to have ended up with some UBS stock. This is likely to raise questions about the constitutional pecking order here as the rule book appears to have been torn up in the rush to salvage CS, but without bondholders present at the negotiating table. The Swiss government is putting taxpayer money on the line to clean up this mess. Any hard to value assets which need to be sold by UBS that result in a loss, UBS’s liability will be capped at 5 Bn Swiss Francs, but the next 9 bn is borne by the government. It does feel awfully like when Lloyds was strong-armed into taking over Halifax Bank of Scotland in 2009.
As of 20th March, the S&P500 in the US is up 0.8%, the FTSE100 is up 1% which is encouraging. We do not think this will turn out to be a repeat of the banking crisis of 2009 largely because banks in general are so much better capitalised than they were back then, there is much less debt kicking around and although the housing market has softened, it is not in crisis as it was in 2008. Banks need depositors to provide short term lending, without it they cannot lend themselves, and without lending, economic activity is cropped. Thus, it becomes important to maintain confidence in the sector, and prevent a mass exodus of depositors, which is why we have seen in the call to action we have in the US and Switzerland.
Unsurprisingly during the past week or two, equity markets have given back much of the gains made year to date and sentiment, which had started to look quite rosy, has become a bit more ragged. In economic terms, whether we see a hard or soft landing (or indeed any type of landing) is a matter of conjecture, but the steep inversion of the yield curve suggests investors expect central banks to be cutting rates again as early as 2024. This would be supportive for bonds, but we are not convinced it is worth a wholesale move out of equities to fund this. If the UK 10-year bonds backs up to nearer 4% we might add more, but at the current 3.3% we are inclined to keep our full weighting to equities and alternatives.
Dr Andrew Mann