24 Nov This is going to hurt ……
If you are going to remove a Band-Aid, the best approach is very often to rip it off quickly, rather than tentatively easing it off. Sure, it might make your eyes water, but the discomfort is seldom long-lasting and certainly more palatable than prolonged discomfort.
This seems to be a reasonable analogy for Jeremy Hunt’s maiden budget, delivered last week. As we have said before, the UK has a thorny inflation problem, it has too much debt and we have been sliding towards recession for most of the year. In fact, Mr Hunt acknowledged we were already in it, not that that will surprise anyone.
His predecessor Kwasi Kwarteng had faced the same challenges, but chose to address them in a very different, and unconventional, way. His approach was to try and stimulate growth. Whilst that might be sound economics for addressing a slowing economy, with inflation running at its highest in 40 years and his expansion plans largely uncosted, it is like to trying to cure an overheating engine by draining out the coolant. Financial markets went into meltdown, the UK lost credibility and Mr Kwarteng lost his job.
There can be no denying the content of Mr Hunt’s budget represents a complete ‘about turn’ from that of the ill-fated Kwarteng era. Some even called last week’s statement a ‘memorial service for Trussonomics’. Much of the content had been anticipated, though there were one or two surprises – very much the Curates Egg, some good, some bad, but overall it did feel like the wound dressing being yanked off.
The major changes can be summarised as follows.
The economy
The chancellor said forecasts from the Office for Budget Responsibility (OBR) show the economy will grow by 4.2% this year. GDP would then shrink 1.4% next year, before rising 1.3% in 2024, 2.6% in 2025 and 2.7% in 2026. In March, the OBR had forecast growth of 3.8% for 2022 and 1.8% for 2023. A lot has changed in that time.
High inflation however is expected to see living standards decline by around 7% over the two years to March 2024, effectively wiping out the previous eight years growth.
Borrowing in the current financial year to April 2023, will be 7.1% of GDP. In cash terms, the OBR estimates the budget deficit (the gap between spending and income) is £177bn in 2022/23.
Public sector net debt is forecast to peak at 97.6% of GDP in 2025/26, and then to fall gradually to 97.3% of GDP by 2027/28.
He announced two new fiscal rules: underlying debt must fall as a percentage of GDP within five years and public sector borrowing must be below 3% of GDP.
Personal taxation
The most eye-catching (or maybe that should read eye-watering) change was the reduction in the annual Capital Gains Tax (CGT) exemption of £12300 in this tax year, to £6000 in 2023/24 before falling again in 2024/25 to just £3000. Any profits realised over these limits will be taxed at existing rates of 20% for higher and additional rate taxpayers and 10% for basic rate (28% and 18% respectively for gains on residential property).
A hefty reduction in the annual dividend allowance, which is the amount of dividend income individuals can receive tax-free. Mirroring the CGT picture, the allowance ratchets down from £2000 this year, to £1000 next year, and settling at £500 in 2024/25. The tax rate applied over these allowances remains unchanged at 8.75% for basic rate taxpayers, 33.75% for higher rate and 39.35% for additional rate.
The above changes make the case for fully using ISA allowances even more compelling.
The additional rate of tax for high earners reduces from £150,000 to £125,140 from April 2023, snaring more people in the top rate. The tax free personal allowances and the threshold for higher rate tax are frozen until 2028. This is not an uncommon tactic, referred to as fiscal drag. As wages rise, a greater share gets taxed (or taxed at a higher rate) and if things are indeed frozen until 2028, the allowances will barely have changed in nine years.
The Inheritance Tax (IHT) nil-rate band and residential nil-rate band have also been frozen until 2028. This means the IHT nil-rate band will have remained at £325,000 since 2009. Over the same period house prices in the UK have risen by around 70% meaning the tax-take from this area has ballooned.
Pensions
This is an area that was widely expected to see some change, but in the end, very little did. The existing freeze to the Lifetime Allowance (LTA) was not extended and will end in 2026 as planned. Rumours of scrapping higher rate relief for contributions, in favour of a single flat rate, have been swirling around for years, but this remained untouched.
The state pension will increase in line with inflation from April 2023, by 10.1%, clearly a sign of the times. The pensions ‘triple-lock’ will be maintained.
Business tax
Windfall taxes will raise £14bn, including a new temporary 45% levy on electricity producers. The Chancellor aimed to soften a blow for businesses with an almost £14bn tax cut on business rates, which would benefit about 700,000 businesses.
Employment allowance will be retained at a higher level of £5,000.
Mr Hunt is wary of tarnishing the Conservatives’ long-cherished mantle as the ‘party of business’, stressing that 40% of all firms will continue to pay no national insurance contributions at all.
Public spending
Government spending will continue to increase in real terms every year for the next five years but at a slower rate. Existing departmental spending under the 2021 spending round will be kept. Then departmental spending will grow at 1% a year in the three years that follow. The Chancellor said departments will need to make efficiencies. However, overall spending will ‘continue to rise in real-terms’ for the next five years.
Voters might endure higher taxes, but public services are politically influential. Mr Hunt acknowledged that, saying he wanted to ‘protect them as much as we can’.
Attempting to dispel any claims his autumn statement would offer a return to austerity, he insisted public spending will grow, albeit more slowly than the growth in the economy.
The outliers in terms of the public purse were reserved for education and health. The Treasury will increase the schools budget, with an extra £2.3bn a year. The chancellor said social care did an incredible job during the pandemic, but an ageing population is putting massive pressure on services. He said he wanted to free up hospital beds by investing in social care, and will allocate £1bn more next year and £1.7bn the year after. Former Labour Health Secretary, Patricia Hewitt, will advise the government on the efficiency of the NHS with the stated aim of ‘Scandinavian quality alongside Singaporean efficiency’. All told, the Chancellor said there will be a £3.3bn increase in NHS funding.
Infrastructure and innovation
The Chancellor was clear the government would focus on economic growth, despite having to find budget savings. He said energy, infrastructure and innovation would be priorities. ‘If we want to avoid a doom loop of ever higher taxes and ever lower dynamism, we need economic growth’ he said.
The government will proceed with a new nuclear power plant at Sizewell C, helping to provide reliable low-carbon power, and this ‘represents the first step on our journey towards energy independence’. He also said he would double investment in energy efficiency of homes and industry by £6bn from 2025.
There was a commitment not to cut capital budgets for the next two years, and then maintain them in cash terms for the next three, though there will be an election before then. They will not grow as planned but it will still increase.
HS2 will be kept, alongside core ‘northern powerhouse’ rail, and new hospitals.
There will be £600bn of investment over the next five years and there will be more devolution deals in England to boost levelling up.
In terms of innovation, he said it would be a ‘profound mistake’ to cut the government’s research and development budget. Funding will be protected, with an increase to £20bn by 2024/25. The chancellor said he wants to turn Britain into ‘the world’s next Silicon Valley’.
Tariffs will be cut to support business supply chains.
Investment zones will be kept, centred on universities in ‘left behind areas’ to help build growth clusters, with further announcements at the spring budget.
Support measures
The government’s energy price guarantee will be kept for a further 12 months at an average of £3,000 for a typical household, up from £2,500 at present. Mr Hunt said there would be more support for households and businesses on the way next year.
He announced new one-off payments of £900 to households on means-tested benefits, £300 to pensioner households, and £150 for individuals on disability benefit.
There will be an additional £1bn funding as a further extension to the household support fund.
Social housing rents will be capped at 7% next year, to avoid rent hikes of up to 11%.
The ‘national living wage’ will rise by 9.7% next year to £10.42 an hour.
Benefits will rise in line with September’s inflation rate, by 10.1%, costing the government £11bn. The benefit cap will be increased with inflation next year.
The imposition of higher taxation and lower spending should combine to help moderate inflation and reduce borrowing, both very necessary goals but a sharply higher tax burden, further impacts households already being buffeted by spiralling energy costs and higher interest rates and our concern is whether the medicine could turn out to be worse than the disease. The Chancellor is attempting to tackle the UK’s economic woes and restore credibility without damaging our longer term economic prospects and this is a tall order. He is clearly of the opinion that easing off the Band-Aid is not the right approach.
Many of the initiatives relate to a period long after the next general election is due, which is early 2025 at the latest. This means some of the pain might not be felt for years to come, and possibly for a new government to contend with. But whilst households might be reeling, Mr Hunt does appear to have placated financial markets. The pound has stabilised, though investors know a long, rocky road lies ahead. The stock market also appears to approve of the ‘tough love’, with the FTSE100 virtually unchanged, though it is up almost 4% since the start of November.
But it was probably bond markets where most investors would have been looking for approval. It was the huge spike up in gilt yields (sharp fall in price) that lit the touch-paper under Kwasi Kwarteng’s budget. The yield on the 10 year benchmark gilt rose to 4.5% in October but this has now drifted back to around 3%, a clear message that bond markets at least see the plan as credible. In our opinion, it is also a sign that they are pricing in a recession for 2023 but that is also likely to mean lower interest rates further down the track, probably in 2024.
In terms of what this means for strategy, we have recently upped our weighting in bonds, albeit marginally and bolstered our commitment to ‘alternatives’. Both aim to provide a bit more stability to portfolios, though fundamentally we do still favour equities and remain overweight. Over the years, stocks have been one of the true great inflation hedges and despite the difficult (economic) road ahead, we still believe corporations around the world will be able to eke out profits and reward shareholders with higher dividends. This will support share prices and ultimately, once investors start to look through the fog to brighter economic times ahead, push stock markets higher.
Dr Andrew Mann
Investment Director