How has the Spring Budget affected markets?

Budget days in the modern era rarely produce big surprises owing to the testing of policies and careful management of expectations ahead of the event. The exception was, of course, the “mini” Budget of September 2022, which has gone down in history for all the wrong reasons and which triggered the rapid removal from office of both the Chancellor (Kwasi Kwarteng) and the Prime Minister (Liz Truss). The consequence of that period of turmoil is that the current government has been forced to play it even safer than usual, ever mindful of the “bond vigilantes” waiting in the wings to deliver retribution.

Thus, the weeks leading up to today’s Budget have seen various policies being floated, before the main elements of the final version were “leaked” to the Times newspaper on Tuesday, taking much of the drama away from Wednesday’s speech. 

There were two main considerations for Chancellor Jeremy Hunt coming into this Budget, and they were opposing forces. On the one hand, restraint was required owing to the tight fiscal position that the government finds itself in; on the other, there is a General Election in the offing (one which must take place by January 2025 at the latest), and Mr Hunt was keen to offer the electorate some incentives to vote for his party. It was clear from all of his pre-Budget communications, which leaned heavily on words such as “prudence “and “responsible”, which consideration Mr Hunt was going to prioritise, despite pleas for greater fiscal profligacy from certain die-hard elements of the Conservative Party.

The fiscal “headroom” available to the Chancellor is calculated by the Office of Budget Responsibility (OBR), a body independent of government and thus not subject to the whims of party politics. Its latest figure of £12.2bn did not allow room for expansive gestures, and any popular headline tax cuts were going to have to be clawed back to some degree by increases elsewhere. In the event, Mr Hunt used up £3.3bn, keeping back £8.9bn as a buffer. Even so, Mr Hunt was probably lucky that the number was struck in January, just before expectations for interest rate cuts started to be reduced. In terms of the economy overall, the OBR raised its GDP growth estimate for 2024 from 0.7% to 0.8% and for 2025 from 1.4% to 1.9%. Inflation is expected to fall to 2.2% on average in 2024 (down from its previous forecast of 3.6%, mainly thanks to lower energy prices) and 1.5% in 2025. 

As in his Autumn Statement last year, Mr Hunt chose to play as his trump card a two pence in the pound cut in the rate of National Insurance (NI) paid by employees. Although the Prime Minster is reported to have wanted a similar cut in the Basic Rate of Income Tax, that would have cost around £13bn versus a more acceptable £10bn for the NI reduction. Furthermore, reduced NI contributions play well with the idea of rewarding those who are working. The benefit to workers in terms of increased take-home pay is set be around £450 per annum on average.

Another headline announcement was an extension of the “temporary” 5p per litre reduction on fuel duty as well as a freeze on the underlying rate of duty for another twelve months. Forecourt petrol prices are a highly visible swing factor when it comes to the perception of inflation and keeping them pinned lower is a canny political move. Today’s announcement is projected to reduce potential inflation by 0.2%. However, the OBR’s future projections assume a normalising of the duty and so there will have to be some payback in the years ahead.

Other favours dangled before voters included a freeze on alcohol duty, an extension of the Household Support Fund, a £5,000 rise in the VAT threshold to £90,000 and a reduction in the higher rate of capital gains tax on sales of residential property (with the intention of encouraging more sellers to boost supply).

On the other side of the ledger, revenue was clawed back through increases in various taxes and duties which were deemed to be not too damaging in terms of votes. These included the abolition of the current “non-dom” tax regime (to be replaced with something less generous), higher tobacco and vaping duties, an increase in Air Passenger Duty for First Class and Business travellers, closing a tax loophole for holiday homes, and extending the current windfall tax on oil and gas production. 

One of the UK’s greatest challenges in recent years has been a lack of growth in productivity, as reflected in the OBR’s comment that GDP per capita remains below its pre-pandemic levels. It is generally recognised that this could be improved by greater investment in education and training, as well as by improving the planning environment, especially with respect to the shortage of housing in the country. Although there were a few helpful announcements, there was nothing one could describe as game-changing. One possible hint of the future came in the intention to fund digital transformation in the NHS, a potential route to providing better value public services without cutting them back. 

In the shadow of the Budget, there was another important announcement today from the Debt Management Office (DMO). This concerned the amount of government debt that would have to be issued in the next fiscal year, of which an increasing amount is needed to pay the interest on existing debt - amongst G7 countries, only Italy has a higher ratio of interest payments to GDP. The final figure of £265bn, some 11% higher than in the current year was higher than the expected £259bn.

We usually take our cue for the reaction to the Budget from the Gilt and foreign exchange markets. The equity market, especially the headline FTSE 100 Index, is much more beholden to influences beyond these shores today. Having said that, the proposed British ISA could be a shot in the arm for UK-listed companies. There has been a steady disinvestment by UK institutions and it would be good to see support from retail investors recognising some of the undoubted value, especially in the small and mid-cap areas of the market. Both the FTSE 250 and Small Cap Indices immediately gained around 1% on the announcement, outperforming the large-cap FTSE 100.

Gilt yields initially rose slightly on the news from the DMO, but ended up a touch lower after the speech, trading in line with global bonds. The pound was steadfastly unmoved by the event.

Overall, and much as we expected, Mr Hunt delivered as politically expedient a Budget as he was able to in the circumstances, although it does little to improve the longer-term fortunes of the economy. Whoever inherits the keys to 11 Downing Street following the General Election (with the odds firmly in favour of Labour’s Rachel Reeves), they will find themselves in a similar position. It would be unsurprising to see a shift towards greater wealth redistribution under a Labour government, although we would not expect markets to tolerate a “tax and spend” spree. Indeed, current OBR projections already build in planned tax increases during the next Parliament. With the election likely to be decided by marginal voters in the centre of the political spectrum, we do not expect Labour’s manifesto to be especially radical from a fiscal perspective.

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