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Before the budget

29 Oct 2024 | 3 minutes to read

A good week for

  • Oil as brent crude recovered, gaining +4.1% in US dollar terms
  • Gold also gained, rising +1.0% on the same basis

A bad week for  

  • Equities weakened modestly across all regions, led lower by Japan (-3.5%)
  • Bonds also weakened, with gilts down -1.1%

UK public sector finances

Ahead of the hotly anticipated budget, government borrowing is in focus. The new Labour executive has already made it clear that departmental public spending will need to rise, and that tax increases will be necessary. At the same time, the government would like to increase investment spending, but doing so, while also maintaining public spending, would require an increase in borrowing.

The latest government borrowing figures show little to improve the picture for the Treasury. Government borrowing in the first six months of the current fiscal year came in at £79.6bn, £6.7bn above the March Budget forecast - though this is partially due to local government finances being particularly prone to revisions.

Central government spending and receipts were closer to the Office for Budget Responsibility’s (OBR) forecasts, despite debt interest payments of £5.6bn in September exceeding expectations. Spending on goods and services exceeded the OBR’s forecast by £2.7bn, but net social benefits undershot the OBR’s forecast by £2.9bn, partially as lower winter fuel payments reduced spending.

With the market tsunami post the Liz Truss mini budget still fresh in the memory, the new Chancellor will be keen to avoid another market upset.

Key to raising borrowing without alarming markets will be redefining the debt rules. This is far from a novel idea – Chancellors frequently reinvent the fiscal constraints within which they operate. However, doing so requires a balance between creating sufficient headroom and maintaining credibility. The more generous the rule redefinition is, the greater the fiscal wiggle room it creates, but so too the chances of a market upset.

The Treasury’s most likely course of action seems to be to redefine the scope of the rules, perhaps adjusting the definition of government debt to take into account more of the government’s assets, thus reducing the net debt position. Basing the rules on public sector net worth is one option, while public sector net financial liabilities is another more moderate proposal.

While the budget could entail material changes from a wealth planning perspective, the economic impact, and thus the impact on the Bank of England’s policy path, is likely to be modest.

US economic data

In the wake of a spate of storms, US economic data remains in focus, especially with regard to the labour market, as the US election and next Federal Open Markets Committee (FOMC) interest rate decision draw closer.

For another week, labour market data was stronger than expected. Initial jobless claims for the week to 19 October totaled 227,000, with a modest upgrade to the prior week to 242,000 from 241,000. Initial jobless claims had been expected to surge, as storm weather disrupted economic activity, and increased the number of workers laid off, albeit on a short-term basis. However, following the usual summer surge, claims have swelled only modestly, peaking at the start of October, and falling back over recent weeks.

The continued resilience of US data explains why markets have repriced the likely path of rate cuts. While futures prices indicated that three cuts were likely after the last FOMC meeting, that number is now one or two. Friday’s non-farm payroll report will paint a fuller picture of the labour market.

Japan economy

Japanese stocks suffered a leg-down last week, as data challenged investor hopes of economic recovery. Business survey data pointed to a marked deterioration in conditions. Japan’s Manufacturing Purchasing Managers’ Index (PMI) declined modestly to 49.0, signaling continued weakness, while the services indicator fell dramatically to 49.3 from 53.1. Within the detail of the survey, this is mostly attributed to the weakness of the external business environment, though domestic activity is not strong enough to offset this.

Other data corroborated this view, with machine tool orders declining 6.4% in September, after a brief recovery over the summer. Inflation also cooled, falling to 1.8%, down from 2.1% in September.

Over the weekend, Japan’s political picture became more complex, with the ruling coalition losing its majority in snap elections.

The ruling Liberal Democratic Party (LDP) lost 56 seats, while its coalition partner Komeito lost eight seats. Together, the ruling coalition's 215 seats puts it below the 233 seats needed to achieve a majority in the Lower House, for the first time since 2009. Meanwhile, the largest opposition party Constitutional Democratic Party of Japan (CDPJ) gained 50 seats, bringing its seat total to 148.

Now, a special session of the Diet must be convened within 30 days of the vote to elect a new Prime Minister, giving the ruling parties and opposition until 26 November to form a government. The most likely outcome is a minority government led by the LDP/Komeito, with cooperation from a 3rd party such as Ishin or DPFP to pass legislation on an issue-by-issue basis. This is likely to slow the pace of policymaking and could increase political uncertainty. This may slow the pace at which the Bank of Japan (BoJ) tightens monetary policy. 

 

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