Market Bulletin - Shifting sands
The UK Chancellor hoped his Budget would deflect attention from poor debt figures, while the US Federal Reserve changed tack to leave rates on hold.
The Budget has long been something of a set piece, complete with a Riverdance line-up of Treasury advisors outside 11 Downing Street, and the Chancellor of the Exchequer holding the red box out at arm’s length for the cameras.
This year, George Osborne needed the theatre, as he had bad news to deliver. (In the event, the subsequent departure of a senior cabinet minister dominated headlines.) He had already broken one of his three fiscal rules – the welfare cap – but last week announced that he was breaking the second one, as he could no longer ensure a year-on-year decline in the national debt. Thus UK government debt in 2015/16 will exceed the previous year’s total.
There were various reasons the target was missed. The government’s decision not to sell its stake in Lloyds, as initially planned, reduced expected 2015/16 revenues, while slowing growth provided the chief structural constraint.
“The key headline from the Budget was the downgrade to the UK’s economic outlook,” said Azad Zangana, senior European economist and strategist at Schroders. “Combined with a lower forecast for inflation, the hit to tax receipts was unavoidable.”
Yet the Chancellor insisted on keeping to the third of his major pledges: to return a government surplus by the 2019/20 tax year. A number of commentators had predicted that Osborne would drop the target; indeed, several had advised it. Instead, he shifted various tax revenues into the 2019/20 year and found funding for new capital projects by reducing spending projections for that same year. The third target remains in place – for the moment.
Growth and productivity forecasts did not provide much cheer either. Osborne reported that the Office for Budget Responsibility (OBR) had reversed its former forecast that sluggish productivity growth would revive. The OBR also cut its 2015/16 UK growth forecast from 2.4% to just 2.0%, and predicted that in coming years it would not rise above 2.1% – gone are the days when Gordon Brown viewed 2.75% as a “cautious” estimate. Yet this revision may simply reflect the OBR’s 2015 optimism, rather than a material shift in the economic outlook.
“Budgets these days seem to be more about politics than economics and this one was no different,” said Neil Woodford of Woodford Investment Management. “The outlook for the UK economy is neither better nor worse following yesterday’s Budget. The OBR is slowly adjusting its excessively bullish outlook for the economy, and as a result the deficit reduction headwinds look more challenging than they did in 2015; but we believe the OBR is still too bullish on growth and inflation. Overall, this was yet again an astute, political Budget filled with some eye-catching initiatives; but it will have little overall effect on the performance of the UK economy in the immediate future.”
Nevertheless, although the Budget made a necessity of finding savings, it also included a number of announcements designed to offer tax boosts to savers, workers and businesses.
A generous rise in the personal ISA allowance (currently £15,240) was announced: in April 2017 it will go up to £20,000. The Chancellor also announced the establishment of a ‘Lifetime ISA’. From April 2017, the new savings vehicle will enable people between the ages of 18 and 40 to contribute up to £4,000 a year, and receive a 25% bonus from the government. Coupled with the expected deferment of changes to tax relief on pension contributions, these welcome announcements have, however, raised questions over the relative merits of the future options for retirement savings.
“I would urge employees not to see the Lifetime ISA as a replacement for pension saving,” said Ian Price, divisional director at St. James’s Place. “Anyone who has a workplace pension is already benefiting from a government ‘bonus’ in the form of tax relief at their highest marginal rate [20%, 40% or 45%], a contribution from their employer, and a tax-free lump sum available after they reach 55.”
Figures from the world’s leading search engine show that Google searches for ISAs tend to peak in late March; in 2015, they reached around double the normal rate in the week of 22–28 March. With markets still low after a troubled opening to 2016, investors contemplating their ISA plans for this tax year don’t have long to turn their thoughts into action.
Meanwhile, investors received a boost when the Chancellor announced an eight percentage point drop in Capital Gains Tax. The higher rate will be brought down from 28% to 20%, while the basic rate will drop from 18% to 10%.
The Chancellor also extended largesse to businesses, pledging Corporation Tax in 2020 will be cut from the planned 18% to 17%. Moreover, from April 2017, some 600,000 firms will not have to pay business rates. To cover the cost of the business tax giveaway, the Chancellor introduced a 30% cap on debt interest payments used by larger firms to cut Corporation Tax bills.
“The Chancellor has listened to our calls for the tax system to be made simpler for small businesses and the self-employed, and taken important action on business rates,” said Mike Cherry, head of policy at the Federation of Small Businesses.
Both the Chancellor, in his statement to the Commons, and the Governor of the Bank of England referred last week to global headwinds afflicting the UK. The latter also pointed to increased uncertainty ahead of the UK referendum on EU membership, as he announced the Bank would leave rates at 0.5%.Yet last week there were tailwinds in evidence, too. The FTSE 100 rose 0.8% over the course of the week, as mining and energy stocks took it above 6,200 for the first time in 2016. The price of a barrel of Brent crude ended the week above $41.
The greatest stock market encouragement came from the S&P 500. Investors and traders alike received two important psychological boosts from the world’s leading index last week; the S&P 500 spent the five-day period above 2,000 points and, for the first time, ended the week above where it had ended 2015. It rose 1.1%.
The late-week bounce came on the heels of the scheduled statement made by Janet Yellen, chair of the Federal Reserve. Yellen announced that the Federal Reserve would not be raising rates as previously planned. In a dovish turn, the Fed dialled down its 2016 rate rises forecast from four to two, explaining that “global economic and financial developments continue to pose risks”. It also argued that inflation was likely to “remain low in the near term, in part because of earlier declines in energy prices”.
The day before the announcement, the publication of US inflation data showed headline inflation up 1% in February. Core inflation (which strips out commodities and food) jumped 2.3%, its largest rise in almost four years, having increased 2.2% in January. Both Capital Economics and Aberdeen Asset Management have recently forecast of a rapid rise in US inflation.
A dovish Fed might send stocks higher, but it sent the dollar lower. That had a knock-on effect for the Nikkei 225, as Japan is reliant on the yen remaining cheap against the dollar. After a quiet first half of the week, the Japanese index ended the period down 1.3%. The falling dollar also hit stocks sensitive to the euro; the FTSEurofirst 300 finished the week down a marginal 0.3%.
Aberdeen Asset Management, Schroders and Woodford Investment Management are fund managers for St. James’s Place.
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