12 Mar 2024 | 5 minutes to read
Last week’s UK Spring budget offered less than some had expected in terms of additional spending. Chancellor Jeremy Hunt had to walk a fiscal tightrope – spending enough to win over voters ahead of the imminent election but still emphasising to capital markets the commitment to fiscal probity. The 2022 Kwarteng/Truss budget is still in the public memory and serves as a cautionary tale to exchequers.
The budget contained lots of messages designed for the electorate: rewarding work (and being hawkish on migration), incentivising innovation and optimising public services spending. However, there were only really two tax announcements of significant size: the 2p cut to National Insurance contributions, costing c. £10bn a year, and the fuel duty freeze, costing c. £3bn in the first year and c. £1bn thereafter.
On the revenue side, a range of measures were announced, though these do not fully fund the tax cuts announced. The eventual abolition of non-domicile tax status is expected to raise c. £3bn in the final three years of the forecast. The continued crack-down on tax avoidance is hoped to raise c. £1bn in the final four years of the forecast, though this may be difficult to achieve. Extending the energy profits levy also adds a further £1bn in 2028-2029 and changes to tax on property tax, tobacco and vapes also bring in about half a billion pounds each in coming years.
Overall, the budget does raise spending relative to the prior forecast by around £13bn in 2024-5. The consequence of unfunded tax cuts is diminished headroom against the government’s fiscal rules, most importantly that government debt as a percentage of GDP should be falling in the final year of the forecast. The Office for Budget Responsibility estimates that public sector net debt as a percentage of GDP will only fall by -0.3% in the final year, shrinking headroom by £4bn to £8.9bn. Given that it is highly likely that fuel duty is frozen for the foreseeable future, the decline is likely closer to 0.1%, leaving only £4bn headroom. Moreover, these numbers assume cuts to expenditure in the next parliament.
The £13bn increase in spending in the first year of the forecast is meaningful at around 0.5% of GDP, and should be modestly supportive for GDP growth. The Bank of England (BoE) may judge this could also support inflation, though frozen duties on fuel and alcohol will weigh on Consumer Price Index. However, data this year has been on the soft side, making a greater case for rate cuts. In addition, energy prices and the Ofgem price cap are likely to continue to weigh on inflation. In May we will get updated forecasts from the Monetary Policy Committee. We expect that the combination of softer activity and more rational assumptions for rate cuts may allow the BoE to land inflation at or below target in the forecast conditioned on market assumptions, making a clearer case for rate cuts.
The broad strength of US data this year has been a cause of concern for some market participants, who may fear that it endangers the chance of a rate cut and even makes a further hike possible. Friday’s non-farm payroll data helped to sooth these concerns. While payrolls rose by 275,000 in February, payroll gains for January were revised significantly lower. The survey based measure also showed a 184,000 decline in employment. Combined with flat labour participation, this resulted in the unemployment rate rising to 3.9% from 3.7%.
While this data is unlikely to bring forward the pace of policy normalisation, it does confirm that rate cuts are likely to come at some point later this year. Market indicators currently price this in for the summer.
China’s National People’s Congress kicked off last week, with the growth target affirmed at 5%.
The Policy session did announce a fiscal easing that should support growth. The general fiscal budget was set at 3% of GDP, with an additional 1trn of spending via other channels. This is the same size as last year but, because not all of last year’s funds have been disbursed, is in effect an increase.
However, there were limited details on two key areas. The first was the consumption support measures announced in recent weeks. The fact that there was no explicit budget allocated to these subsidies suggests that the scope may be smaller, or will have to be funded from local budgets. The second was real estate sector support, where there was a notable lack of announcements. While there are a number of policies in place that could still support the real estate sector and therefore the economy. However, without a step up in policy, it seems likely that sales volumes could fall further, weighing on growth.
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