In this week’s blog:
- Whilst the Budget contained no real surprises it did highlight the parlous state of the UK’s finances
- There was some dispute about assumed growth levels being used by the Chancellor with opponents accusing him of being too optimistic
- In reaction equity and bond markets were generally unmoved with investors looking elsewhere – particularly Greece and the US
- Economic data was generally positive and supportive of the view that the global economy is continuing to recover – albeit in an imbalanced way
- The UK economy continues to throw out mixed signals and is likely to do so for a while according to the BoE governor, Mervyn King
- With the end of the tax year imminent – taxpayers are being advised to move quickly to ensure they don’t waste any of their usable tax allowances
Balancing the Books
Last week’s Budget – the last before the impending general election – was, unsurprisingly, much in line with expectations. The numbers were tweaked here and there and the Chancellor predictably used the opportunity to try and pick up a few votes by sprinkling a little extra money the way of first time buyers and small businesses. But there was one thing he couldn’t really change and that was the scale of the numbers – they were enormous. Mr. Darling told Parliament that for the fiscal year 2010-11 the government anticipated receiving revenue of £541bn compared to planned government spending of £704bn. The difference – the budget deficit – is therefore £163bn and this is the amount that has to be borrowed by the next government, regardless of colour, via the issuance of gilts. But the coming tax year was always going to be difficult in the aftermath of one of the worst recessions for many decades – the UK economy contracted some 6% before growth resumed in the last quarter of last year. And it was future growth rates being used by the Chancellor that seemed to upset opposition parties, who claimed that the Treasury’s assumption of 3% growth next fiscal year and 3.25% in the three years thereafter was far too optimistic. The point here is that faster growth will shrink the deficit sooner and bring overall debt down.
Not all agreed that the assumptions made were unrealistic. Writing in The Times, economist Anatole Kaletsky said that when an economy starts expansion with huge excess capacity and under-utilised labour as it does today, history has shown that the deepest recessions, are followed by the strongest recoveries. Kaletsky went on to point out that in the four years after the last two recessions, annualised growth averaged 3.4% and 3.7% respectively so if the growth predicted by the Treasury materialises, then planned reduction in government borrowing from 12% of GDP this year to 4% in 2014-15 should be achievable. This will also mean that government debt-to-GDP ratio will stabilise around 78% – slightly stronger than in Germany, France or America and much better than in Italy or Japan. The final part of the conundrum would be how to address the possibility of rapid economic growth failing to not actually happening – here he suggested that there has been a shift from a laissez-faire approach to more interventionist by the Treasury, which would help drive growth.
In the aftermath of the Budget the experts trawled through the vast amount of ensuing press releases and briefing notes from HMRC and the Treasury et al. With the euphemistic devil in the detail aspect there was always going to be scope for disagreement on how the figures add up. One of the Chancellor’s main planks to reduce government expenditure is to be via Whitehall efficiency savings of some £11bn, but this quickly came under fire from the Institute of Fiscal Studies (IFS). Robert Chote, the Institute’s Director, said the public had a right to expect government to cut out waste at all times, not just when spending plans were tight. The IFS also highlighted the fact that half of the proposed savings were in departments whose budgets have been protected by the government such as health and education. And some felt that even if growth did pick up it would be the wrong sort – the respected Ernst & Young Item club believes growth will be skewed towards exports which generate smaller increases in tax-receipts than a consumer-led upturn. One thing everyone seems to agree on though is that, against this parlous backdrop, interest rates are very likely to continue to stay lower for longer.
After many tortuous months of political wrangling, President Obama’s much vaunted healthcare reform package finally made its passage through the US legislature and shares in many US healthcare companies rose, with investors seeing the benefits of greater certainty and increased demand offsetting potential price controls. This set a positive tone for equity markets last week, although nerves were frayed early in the week as investors fretted as to whether the eurozone-sponsored bail-out package for Greece would ever come to fruition following comments from Germany. The country’s Chancellor, Angela Merkel, had insisted over the weekend that no decision had been made on a possible bail-out fund. The waters were still muddy by the end of the week with a lack of clarity around a possible hybrid solution to set up a standby facility involving the IMF and EU. China weighed into the fray with Zhu Min, a deputy governor of the People’s Bank of China, reportedly saying that the Greek debt crisis was just “the tip of the iceberg”. This was all grist to the mill for the bears, with Simon Derrick at the Bank of New York Mellon commenting “This might well signal the point that we . . . start talking about a ‘eurozone structural crisis’ instead”. As ever, the markets took affairs into its own hands and the euro touched a fresh three-week low against the dollar and also hit a 17-month trough against the Swiss franc as investors headed for the exit.
On the economic front, most of last week’s data was positive and re-inforced support for continued global recovery. In the eurozone the purchasing managers’ index (PMI) for the 16 member states rose to its highest level since November 2007 and German business confidence soared to a two-year high, alongside news that orders for big-ticket goods rose for the third consecutive month. Over in the US it was a similar story, with the Commerce Department reporting a rise in durable goods orders once again in February and unemployment fell more quickly last week – the number of benefit claims fell by 14,000. Not so good though was news on the vital US housing market – here new-home sales hit a record low for the second consecutive month. Over in the emerging markets, China has overtaken Germany as the world’s top exporter (with the US coming third) and the country is likely to post its first trade deficit for six years as its imports swell – regarded as positive by Zhong Shan its prime minister. China’s huge trade surplus has been a cause of upset to the US who believe China’s currency, the yuan, is too cheap and is hurting American exporters, so a deficit might take the pressure off China to revalue. “A further rise in the yuan by a very small magnitude might cause fundamental changes to exporters in China” said Zhong Shan.
Here in the UK, mixed economic data released last week means the outlook remains somewhat cloudy and unsure – a point made last week by Bank of England governor, Mervyn King. “Even if growth rebounds, the level of activity is still very likely to remain weak for a considerable period. The economic environment is likely to continue to feel far from normal for some time” he said. Figures showed that business investment fell in the final quarter of last year despite a recovery in growth, although it was better news from the high street where retail sales showed a better than expected rise of 2.1% last month. And there was a boost for both the Chancellor and the BoE governor with news that the Consumer Price Index fell from 3.5% to 3% last month – the BoE has a 2% target to hit and Mr. King has said for some time that inflation will gradually fall back into range. It also means that interest rates are unlikely to be increased at the next MPC meeting.
So by the end of the week global financial markets had, for the most part, made useful gains. In London the FTSE100 rose 1% as the market took a phlegmatic view of the Budget and so too did the gilt market. News that next year’s borrowing is going to be £163bn was really only telling the fixed-interest market what it already knew and prices only edged marginally lower – more in reaction to the US bond markets than anything Alistair Darling said. Over in the US, concerns about sovereign debt – or more to the point, the vast amounts of new Treasuries schedule to be issued – came to the fore. The yield on the 10-year Treasury bond rose to its highest level for nine months – 3.88% – after a series of poorly received debt auctions; a sign that the demand for government debt might be finally waning. But Paul Dales at Capital Economics argued that the jump in Treasury yields was unlikely to develop into a bloodbath. “Fears over excessive debt issuance, waning foreign demand and the credit standing of the US government are all overdone. We continue to think that by the end of the year yields will have fallen back to around 3%”.
The effects of the Budget are not always easy to work out so what did it mean for you? The Sunday Telegraph thought about this and came up with a few ways to beat the government’s so-called stealth taxes, with the paper saying that the government likes to keep taxpayers confused and true to form has introduced a few more stealth moves. The strategy is not to increase tax thresholds in line with inflation which means more people slip into the net as their income and wealth increases. Inheritance Tax is a classic example – the Nil Rate Band has been frozen at £325,000 for the next four years, even though Alistair Darling had said it was due to rise to £350,000 two Budgets ago. The paper advised people to pay into their pensions – not withstanding the attack on high earners – and to utilise capital gains tax allowances. As we approach the end of the tax year it makes sense to carry out a tax audit to make sure you don’t miss out and because of the way Easter falls, this week is your last chance to use your allowances. The Financial Times ran with a ‘Use it or lose it’ headline to reflect this and reminded its readers not to waste their Individual Savings Allowance (ISA) – if you’re over 50 you can invest up to £10,200 but otherwise the ISA limit is £7,200. Trusts will be liable to the new 50% tax on any income but don’t panic, said Grant Thornton – there are ways to potentially mitigate. So the message is clear that, looking ahead, we probably need to plan even more carefully.