Two weeks on from the UK Budget, overseas investors do not seem deterred but they may employ a ‘wait and see’ attitude, says Michael Browne, CIO of Martin Currie.
We’re two weeks on from Rachel Reeve’s inaugural budget which brought the largest increase in tax as a percentage of GDP since 1993. The budget looks to raise £40 billion in taxation, the majority of which is through an increase to employer National Insurance (NI) contributions. It also projected the largest rise in fiscal spending since 2010, excluding the COVID year of 2020.
UK bond yields were initially subdued on the announcement but as investors digested the budget’s implications for borrowing, inflation, and growth, yields began to rise. Importantly, the market is now pricing in closer to three rate cuts by the end of 2025, versus. the assumed five cuts prior to the budget.
Firms will pay NI on workers’ earnings above £5,000 from April, down from £9,100 currently, with the rate increasing from 13.8% to 15%. It is expected that most of the increase in tax will be offset through higher prices and lower wage increases and reduced employment. These three combine over time to reduce the growth and raise the longer-term inflation forecasts. There must be a risk that the employee heavy sectors of retail, leisure and pubs/restaurants shed labour aggressively once Christmas has passed. As a result, gilt yields moved to their highest levels of the year and reflect a slower pace of BoE rate cuts that are now anticipated. The most recent 10-year Gilt auction was not well subscribed, so it clear investors have become increasingly cautious.
But this is not a repeat of the Truss ‘mini budget. For context, the yield moves are still just a third of the 100-basis-point rise seen in yields over the three days that followed Truss’ budget. However, assuming such bond prices are sustained, and rate cuts are indeed curtailed, this construct has the potential to dampen the outlook for domestic-facing equities and lead to a further shallowing of a domestic recovery. However, this will dampen, if not remove the inflationary impact of the budget as well. Rates cuts will be slower at first but the destination of 2.5% remains our central scenario.
Regarding our UK portfolios, this does not portend a wholesale shift in our investment strategy, but it is unhelpful in the short term – all eyes are now on the Monetary Policy Committee meetings. A good example of this is the housebuilders that were aggressively sold off in the wake of the budget, even though, buried in the OBRs forecast is an expectation that property prices will rise 15% over the next 5 years, at a faster rate than previously expected.
The government’s long-term spending review is next spring, when tougher decisions may be on the cards. However, this budget is unlikely to deter the mix of overseas investors but may induce a ‘wait and see’ attitude. Right now, the UK remains undervalued and offers stability. Confidence will take time to build, but it will come.”
Main image: richard-horvath-OcXxgXYucHo-unsplash
