Economic Insight UK Budget 2016

With the upcoming EU referendum, politics was back at the fore, and whilst the Chancellor may have wanted to opt for a more generous package, slowing global growth has hampered Government revenue, providing little in the way of wiggle room. Nonetheless, although growth forecasts were revised down, the Government has managed to remain on target to eliminate the deficit by 2019/20 – although some may see the additional £3.5 billion ‘efficiency-saving’ required as something of a fudge factor.

The theme of this year’s Budget statement was “a Budget to put the next generation first” with a focus on encouraging mid and small-sized businesses – the backbone of most economies – as well as encouraging individual saving and investment. Our financial planning team will cover the details of the changes from a personal finance point of view, but here we will focus on some of the broader economic elements of the speech.

Brexit politics

The Budget is always used to advance a political agenda and this year was no different. Aside from general jibes at the main opposition and their erstwhile political partners, the Liberal Democrats, the main thrust was naturally around the EU referendum. Whilst we remain apolitical on the subject matter itself, we will continue to assess the potential impact on the investment environment, and will be releasing a note on this shortly.

The Chancellor of the Exchequer, on the other hand, is taking every opportunity to push the ‘remain’ campaign, and it was interesting to hear him cite the politically independent Office for Budget Responsibility (OBR). Although the OBR was at pains to note that it was assessing the long-term pros and cons of membership, the Chancellor did mention the following from their report:

“…a vote to leave in the upcoming referendum could usher in an extended period of uncertainty… [and] have negative implications for activity via business and consumer confidence and might result in greater volatility in financial and other asset markets”.

At the same time, the Chancellor cut taxes and duties specific to the oil & gas industry – another opportunity to highlight the ‘better together’ theme on the back of last year’s Scottish referendum. All in all, more fuel for the fire, but there was a clear pressure to deliver a bit of a ‘give-away’ budget to support popular opinion ahead of the vote in June.

Challenging backdrop

What made delivering a generous Budget harder was the weakening economic outlook. Going into the Budget, we already knew that the global economy was slowing, and economic indicators in the UK have been deteriorating. Although the employment situation looks reasonable, measures of economic activity such as industrial production have been falling, and even the services sector, which dominates the UK economy, has been signalling a sluggish outlook. This is a key theme that we have been highlighting through our house view: we are in a structurally slow-growth environment encumbered by continued high debt and excessively loose monetary policy. GDP growth last year disappointed even the downgraded forecast of 2.4% (it was just 2.2%) and this time around the OBR downgraded its forecasts once again, more than reversing the upgrades announced in the Autumn Statement.

Another key factor in the health of the country’s balance sheet is the annual deficit, which determines how much we have to borrow every year to meet our spending needs. Slowing growth has a negative impact on Government revenues and there was some suggestion ahead of the Budget that the current target to eliminate the deficit by 2019/20 would be missed. In the event, the OBR agrees that this target can still be met, although this does assume the Government can deliver on its rather vague intention of an additional £3.5 billion in savings on Government spending by 2020.

Detail rich, impact light

The bulk of the announcement covered a wide range of topics. No doubt there are some causes and issues that are dear to peoples’ hearts (as someone who grew up in Lowestoft it was great to see a commitment to build a third bridge) or cause specific umbrage, but in aggregate the actual impact on economic and investment performance is likely to be limited.

Announced were a range of business reforms looking to stimulate domestic firms, including a proposed cut to Corporation Tax down to 17% and further moves to extend small business relief. At the same time, more measures were announced to further curtail some of the tricks that large multi-nationals use to exploit global tax regimes – such as strengthening withholding tax on royalty payments used to move funds overseas and making it less attractive to use debt-issuance strategies aimed primarily at reducing UK tax liabilities.

On the community side, the Government also produced a range of proposals, the most impactful of which could be the imposition of new levies on firms manufacturing sugary drinks in two years’ time, with the revenues used to fund an expansion of sporting activities for children.

There were relatively few revenue-raising or expenditure-reducing measures, aside from an increase on tobacco of 2% and an increase in the standard rate of insurance premium by 0.5%. Expected reforms to pension savings also didn’t manifest.

Conclusion

We believe that slow global growth is a theme that is set to remain for a number of years as high levels of debt and excess liquidity increasingly act as a drag on the global economy. The result was an unsurprising downgrade for the UK’s growth outlook, which somewhat tied the Chancellor’s hands in terms of the giveaways he could supply ahead of the EU referendum, which was clearly on his mind.

A range of crowd-friendly policies were announced, and the Chancellor did well to keep the deficit reduction plan on schedule, even if it did require a fudging-figure or two – there will be another £3.5 billion of savings before 2020 but those details won’t be forthcoming until later budgets.

There was little today to really impact our investment strategy, with the outlook more dependent on major global factors such as the direction of US monetary policy and the debt unwind in China. We remain cautiously invested, favouring assets with low correlations to equity and bond markets as well as tactical positions in cash.