24 Mar Rishi Sunak’s £6bn balancing act
In our last Budget note in October 2021, we highlighted our growing concern about inflation. At the time, Rishi Sunak said inflation would probably average 4% over the course of 2022 and whilst, at the time, he could not have predicted the surge in energy costs brought about by Mr Putin’s incursion, 4% now looks something of a gift. The official UK inflation number, handily announced on the morning of his speech, came in at 6.2%, the highest in 30 years.
The chart below highlights just how much the inflationary picture has changed in the UK:
Given the strain on households as a consequence of vastly higher energy costs and inflation generally, made worse by events in Ukraine, yesterday’s Spring statement was always likely to morph into something more akin to a full-blown Budget. The Office for Budget Responsibility (OBR) suggests living standards in the UK will fall by 2.2% during 2023. Whilst this does not sound much, it would represent the steepest decline since the 1950s. In response to this, Mr Sunak decided not to tamper with the benefits system or throw additional cash at public services, which is slightly surprising.
He is undoubtedly trying to reconcile his oft-stated desire to get public finances on a secure footing with increasing demands from across the political spectrum to help households with tax concessions. Added to which, he now has an inflation problem which in itself makes household finances worse. His response to this challenge was that ‘more borrowing is not cost or risk-free……. that’s why we will continue to weigh carefully calls for additional public spending’.
Before the Chancellor took to the despatch box, rumours had swirled of a ‘giveaway’ to provide welcome relief to ailing household finances, and this was perfectly plausible given the improvement in government finances. It is worth remembering that in the run-up to the invasion of Ukraine, the UK economy was rebounding (from COVID) quite nicely, meaning tax receipts were up, and welfare spending down, both classic hallmarks of economic expansion.
As it turned out, he exercised more restraint than we expected, preferring to keep some dry powder in case things get worse. Added to which he will be mindful of an election looming in 2024, so it is not inconceivable he wants to tuck something away for some pre-election ‘goodies’. What is surprising though is announcing tax cuts so far in advance since this numbs the ‘big reveal’ in 2024 and also ties his own hands to some extent.
The Chancellor said ‘my tax plan delivers the biggest net cut to personal taxes in over a quarter of a century’ as he addressed The House of Commons on Wednesday. Whilst this might be true, it is not the whole story and it is worth pointing out he is simply giving back about a quarter of the additional tax he announced last year, and around one pound of every six in tax rises since he entered No11.
His measures represent a gesture but in themselves will not provide much shelter to households struggling with a pickup in inflation. Indeed, the government’s fiscal watchdog estimates inflation will hit a 40-year high of 8.7% this year, with further costs set to bite next month, when the cap on domestic energy bills rises by 54%.
Below is a summary of some of the key changes outlined, starting with some of the measures aimed at providing some financial help to individuals and businesses:
Support schemes
• Increasing the threshold at which individuals start paying National Insurance by a very healthy £3,000, which he said would help 30 million people and from July will align with the income tax personal allowance
• From 6 April 2022, Class 2 National Insurance liabilities will be reduced to nil on profits between the Small Profits Threshold and Lower Profits Limit. This will ensure that no one earning between the Small Profits Threshold and Lower Profits Limit will pay any Class 2 National Insurance, while allowing individuals to be able to continue to build up National Insurance credits
• Cut the basic rate of income tax to 19% from 20% in 2024, a move worth £5 billion per annum and the first reduction in 16 years. Whilst two years away, Mr Sunak wants to be seen as a tax-cutter, which so far he has not
• A reduction in fuel duty by 5p per litre until March 2023, the biggest ever cut in the levy and worth £2.4 billion. Combined with a previously announced freeze in the level, this measure is purported to be worth £5 billion
• Scrapping the sales tax on domestic energy efficiency measures such as insulation, solar panels and heat pumps
• A doubling to £1 billion a program of grants for struggling households
• Raising the employment allowance to £5,000 (from £4000), representing a tax cut for half a million small businesses
• A promise to cut taxes for business investment in the autumn
The economy
• The economic recovery over the past year has exceeded expectations, with GDP growth of 7.5% in 2021. The UK economy recovered to its pre-pandemic level around the end of 2021. Across the final quarter of 2021, GDP was on average 0.4% below its pre-pandemic level
• Taking into account the economic recovery to date, continued global supply chain pressures and the initial invasion of Ukraine, the OBR expects UK real GDP to grow by 3.8% in 2022. It is then forecast to grow by 1.8% in 2023, 2.1% in 2024, 1.8% in 2025 and 1.7% in 2026
• Inflation as measured by Consumer Prices Index (CPI) has risen to a 30-year high and the OBR forecasts it to remain elevated through 2022 and 2023, peaking at 8.7% in Q4 2022. On an annual basis, inflation is forecast to average 7.4% in 2022, before decreasing to 4.0% in 2023 and 1.5% in 2024. Inflation is then forecast to be 1.9% in 2025 and 2.0% in 2026
• Borrowing over the next fiscal year is now forecast to be £99 billion, £16 billion higher than previously expected, with debt interest costs hitting a record £83 billion each year. Further into the future, borrowing predictions were slashed, leaving them a cumulative £29 billion lower over five years
The stock market barely moved and actually ended the day down a few ticks. This wasn’t altogether surprising given its recent winning streak. The biggest reaction though was seen in government bonds, where yields fell (and prices rose). Pretty much since the start of the year, bond yields have risen (prices have been falling) as they adjust, rather belatedly in our opinion, to the prospect of higher inflation and interest rates.
Yesterday’s reaction though says less about Mr Sunak’s announcement and more about the belief that aggressive rate rises would pile further misery on beleaguered households. Bond investors are thus of the opinion that interest rates will go up at a more pedestrian pace to provide families with more slack at such a difficult time.
This argument is not unreasonable but in our view the Bank of England has a sole function, and that is to control inflation. Taking their foot off the brake and holding off raising rates, has the potential to allow inflation to run unchecked and this could arguably be even more damaging. So it is not just the Chancellor who is faced with a dilemma. Andrew Bailey, the Governor of the Bank of England also stands ready to tackle the tightrope.
Spring statement aside, investors’ eyes are firmly focused east towards Ukraine and this will largely dictate the direction of markets for the time being. Given the uncertainty, it is hard to claim equities are cheap, but given the enormous upward pressure on inflation, they certainly look better value than bonds, and this is reflected in our asset allocation.
We hope you find this update useful but if you have any questions or need more information, please feel free to contact your adviser, who will be happy to help.
Dr Andrew Mann
Investment Director