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The UK Budget – a few thoughts


The Chancellor of the Exchecquor (UK finance minister) Phillip Hammond has delivered the annual UK budget. We take a brief look at the highlights and at how the market has reacted.

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The UK Chancellor had two options:

  • Play a sound economic budget and continue with austerity measures.
  • Play it political and spend to invest.

Hammond opted to go somewhere between the two claiming to have gone for a “balanced budget”. It was not a Budget to blow the lights out but it did add to spending. It was a budget full of downgrades to economic forecasts (especially for growth and productivity) but also for the budget deficit. Growth is now expected to be below 2.0% across the forecast range of five years for the first time in decades. UK growth has disappointed in 2016, as the UK has moved from the top of the G7 GDP performance to the bottom in just three quarters and is the only country to see annual growth deteriorate in that time. The Office of Budget Responsibility also cut productivity growth expectations, which have also been missed every year since they were introduced in 2009. The budget deficit is expected to fall back below the Chancellor’s 2.0% fiscal rule next year to £25.6bn or 1.1% by 2023. This will give him some £15bn of headroom up to the 2.0% limit but this is still around half of the headroom previously expected. The National Debt is expected to peak this year at 86.5% of GDP before falling back to 79.1% by 2023. This does though significantly rely on growth forecasts being accurate (given the recent downgrades and slow Brexit negotiations this is no given) and productivity hitting target, something repeatedly missed over the years (see below).

Housing measures were the big announcement at the end of the speech, with measures to increase capital spending by £44bn over 5 years, increase housebuilding to 300,000 and cutting stamp duty for houses for first time buyers below £300,000 and doubling council tax for “empty properties”. Measures to improve productivity were also announced with various education programs and some transport projects, but as usual these seemed to be tinkering around the edges. Overall £2.3bn on R&D which is only around £500m higher than previously. Not a huge splurge on that will drive productivity unfortunately.

Hammond has also looked to improve the political environment for the Conservatives by adding extra cash for the NHS and more for Universal Credit (i.e. benefits). He also adding money for Brexit preparations with another £3bn over the next two years.

This is not a budget to ignite productivity, but will be more for the headlines in the papers tomorrow.

 

The UK productivity issue

This has been a problem across western economies and the UK has seen weak productivity since World War II. The implications of this means that weaker productivity means lower tax receipts and a larger budget deficit. But the concerns over the lack of productivity growth are that it eats into the headroom of around £15bn to play with for future spending pledges.This is where the politically intriguing factors come in. With the Conservatives so precariously positioned this is an attempt to improve their standing amongst voters. There is a real political problem given that real wage growth is negative and the millennials are the first generation to be worse off than their parents. Real wage growth is currently around -0.6%.

UK productivity

Why is productivity growth so bad in the UK? Poor education and digital illiteracy of an aging population, in addition to a lack of public infrastructure and R&D investment. This budget does a little to tackle that but no way far enough. Ultimately there is also a lack of investing by companies. On an economic basis, weak wage growth has allowed employment to increase but at the expense of investment. There is also an argument to say that on the stock market, dividend payments and share buybacks have been preferred to investment. This puts money into the hands of savers and is an economic withdrawal.

 

Market Reaction

Markets initially sold sterling, whilst the 10 year Gilt yield fell about 3 basis points but has since rebounded along with sterling. The market fell initially on the concerns over the growth and productivity downgrades, but the rebound seemed to come on the housing announcement. All in all a Budget with little real market moving factors however has proved to be marginally sterling positive in the wake. Sterling has traded within a broad range of around 70 pips, whilst the 10 year Gilt yield is around 1 basis point away from before the speech.

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