Budget reaction

Neil Williams, Group Chief Economist at Hermes Investment Management, reacts to today’s UK Budget: 

Post-election Budgets are rarely ‘give-aways’ and today’s was no exception – with the Chancellor looking to correct at a politically advantageous time (the start of the term) up to £17bn in spending-slippage relative to plans.

The onus as expected will fall on targeted welfare cuts, which together with the raising of personal tax thresholds and a national living wage, the Chancellor hopes to incentivise more people into work. In hard macro terms, time will tell how this trade-off plays out in sustaining what’s been an impressive UK growth-momentum. Given his aim was flagged in advance, it should not surprise financial markets.

Other than that, with the UK’s ‘sugar rush’ continuing and a smoother path of deficit reduction, equities and conventional gilts should welcome the preservation of his growth projections, forthcoming corporation tax and bank levy cuts, and yet tenure still of the fiscal reins.

But, the ‘only’ £3.5bn lower gilts supply now planned for 2015/16 (at £127.5bn) will disappoint some, given the coming proceeds from bank asset sales, and inevitable political temptation of tax cuts at the end of this Parliament.

So, let’s not get carried away. The fiscal screw will have to stay tight if the underlying budget deficit is to be whittled down and returned to the black in 2019/20 – one year later than expected in his March Budget. Recovery has helped, but better growth should have squeezed the deficit more than it has.

First, the deficit is still high. Even including special items like the transfer of the Royal Mail Pension Plan and QE profits, the near 5%-of-GDP headline deficit for 2014/15 was still the G7’s widest after Japan.

Second, while the headline deficit falls on better growth, the structural, less growth-sensitive part of the deficit will fall by less, begging further reform and consolidation.

And, only last year is the net-debt-to-GDP ratio expected to have peaked, at 81% – disappointing given real GDP is 5% up on its pre-crisis peak. This 81% ratio is more than twice Japan’s was, when Japan limped into a ‘lost decade’ in the mid 1990s.

Financing this debt may become more troublesome if the UK has later to deal with the effects of a ‘Brexit’, which in my opinion is a risk case only.

This means, for financial markets, a blend of fiscal consolidation – whether skewed toward spending cuts or tax hikes – and ways to protect recovery are still needed.

Meantime, the need to assess the growth impact of his measures, together with low CPI inflation and an unfixed euro-zone, should keep the Monetary Policy Committee (MPC) ‘sitting on its hands’. The first BoE rate hike still looks off the cards until around the next scheduled Budget, in spring 2016.