Keeping your balance

A year ago, Chancellor Jeremy Hunt presented his first Autumn Statement in the aftermath of the disastrous “mini” Budget delivered by his immediate predecessor Kwasi Kwarteng. It was time for a “safe pair of hands” to reinstate confidence in the government, of which Prime Minister Rishi Sunak had just taken the reins following the departure of Liz Truss. Hunt duly unveiled nothing that would upset financial markets. Indeed, he introduced a well-received programme of fiscal tightening, although much of it was carefully timed not to take effect until after the next election, which must take place by January 2025 at the latest.

The prelude to the current statement was much less fraught. Even so, a moribund economy against a background of higher interest rates offered the Chancellor limited room for manoeuvre. October’s fiscal deficit came in a little higher than expected owing to the increasing cost of servicing the country’s debts, but that damage was limited by higher-than-forecast tax revenues. One positive fiscal side-effect of higher inflation is that nominal profits and wages tend to rise too, leading to higher nominal tax payments. The benefit to the government has been amplified by last year’s decision to freeze income tax bands, meaning that more people have been dragged into a higher tax bracket, so called “fiscal drag”. It’s a neat trick politically, because many people will not be aware of the imposition, tending to focus more on headline income tax rates.

And, naturally, it is the headlines that start to matter more as we approach general elections. Today’s Autumn Statement could be seen as firing the starting gun for the next race towards 10 Downing Street, although opinion polls would suggest that Labour leader Sir Keir Starmer left the starting gate a long time ago.

The lead up to the statement, in what seems now to be the accepted modus operandi ahead of such events, featured a trail of hints and leaks as to what might be announced, all designed to test expert reaction and voter preferences. We would observe that the key initiatives delivered fall into two categories: what’s good for the long-term health of the economy; and what grabs votes.

In the first bucket came a commitment to extend and make permanent the £9bn-a-year tax break for business, a policy that was splashed across the morning’s business pages. It is directed at spending on IT equipment, plant and machinery and allows for full deductibility against taxable profits. We applaud such a pledge. One of the greatest weaknesses of the UK economy in recent years has been the lack of productivity growth. That has been blamed variously on the extended fallout from the financial crisis to the effects of Brexit and the chaos within government, all of which, no doubt, have contributed. Today’s announcement - although on a much smaller scale than adopted by the Biden administration in the US with its multi-hundred-billion-dollar CHIPS Act - is intended to kick start much-needed investment in the country’s technology capital stock. Crucially, if it is, as currently intended, a permanent feature of the fiscal landscape, it will encourage companies to take a longer-term view of their investments in this key sector.

On the personal taxation front, the last few weeks have seen ideas floated for an abolition of Inheritance Tax or a one penny reduction in the Basic Rate of income tax from 20p to 19p. One of Prime Minister Sunak’s ambitions is to get this rate down to 16p, should he survive to see it through. In the end, though, the Chancellor opted for a reduction of 2% in the rate of National Insurance paid by employees. This will kick in on 6 January 2024 and it uses pretty much all of his existing fiscal headroom.

There is plenty of water left to flow under Westminster Bridge before the election, and it is already being suggested that the income tax reduction will be announced during the March Budget. It is not beyond the bounds of possibility, although unlikely, that there will be one more Autumn Statement ahead of the polls, and so there is an element of wanting to keep some dry powder for the campaign.

Market reaction has been limited. This is probably a good thing, as markets have tended to react negatively in recent times to fiscal developments. We usually look at market reaction to these statements through the lenses of currency and bond markets, which tend to be where investors’ response is best reflected. The pound did fall by around a cent against the US dollar during Mr Hunt’s speech, but this seems to have been on account of a better-than-expected employment data release in the United States resulting in a stronger dollar.

Gilts had been rallying into the speech and then gave back their gains but showed no great divergence against other major developed bond markets. It seems as though the OBR’s new economic projections contained few surprises. It concluded that the UK will not fall into recession in 2023 but downgraded its longer-term sustainable growth forecasts while tweaking its inflation expectations higher.

The UK stock market is much less directly affected by domestic policy than in the past, especially within the realm of the large capitalisation FTSE 100 Index. The main reason for the index lagging other markets today appears to be a near-5% fall in the oil price, which is dragging down the share prices of oil majors Shell and BP. That is not related to the statement.

Investors can now return to their task of evaluating the current inflation, interest rate and economic cycles, both here in the UK, and, probably more importantly, in the United States and China, which remain the dominant forces in terms of their impact on global growth.

We continue to believe that there is some light visible at the end of a long tunnel which has seen both bond and equity markets struggle for the last two years, meaning that balanced portfolio returns have been disappointing. Inflation does appear to have peaked, and there will soon be scope for central banks to reduce interest rates, laying the groundwork for a new economic growth cycle.

I joined our Quarterly Markets webinar for Q1 2024 to discuss these matters, which you can watch via the link below. 

Opinions, interpretations and conclusions represent our judgement as of this date and are subject to change. Tax treatment depends on the individual circumstances of each client and may be subject to change in future. All statements concerning tax treatment are based upon our understanding of current tax law and HMRC practise and can be subject to change.

The information in this document is believed to be correct but cannot be guaranteed. Opinions, interpretations and conclusions represent our judgment as of this date and are subject to change. Past performance is not necessarily a guide to future performance. The value of assets such as property and shares, and the income derived from them, may fall as well as rise. When investing your capital is at risk. Copyright Investec Wealth & Investment Limited. Reproduction is prohibited without permission.