Budget 2021: look to the long term, Rishi
Budget 2021 comes amid an extraordinary set of circumstances. The key question is whether the measures announced by the Chancellor will sustain the UK’s economic and financial market recovery in the years ahead, says Richard Buxton.
In every downturn, the UK Government’s finances turn down sharply. Tax receipts fall as job losses, bankruptcies and subdued spending impact the three big sources of revenue for the Treasury – income tax, National Insurance and VAT. But Government spending must rise to cushion the impact of a recession, through unemployment benefits and welfare payments.
There is always a moment at the depths of a downturn when the Government’s budget deficit looks awful and the prospect of a return to more balanced books nigh impossible.
Clearly this pandemic has a rather different dynamic, as the Government measures to support the economy from complete collapse during extended lockdowns, has pushed their spending to levels unprecedented outside wartime. Roughly 75% of the increase in the budget deficit has arisen due to these support measures – about £200bn. Today’s extension of such support until September will only increase the scale of this spending, all funded through borrowing.
Whilst tax receipts have fallen during the pandemic, they have done so only modestly – testimony to the success of the support in limiting the rise in unemployment and bankruptcies thus far. Tax receipts as a percentage of GDP have remained roughly in line with their long run average of 37% of GDP.
Government spending, by contrast, has risen from its more usual level of 40% of GDP to 55% and rising. Hence the Chancellor’s desire to ‘level with the British people’ on the unsustainability of current levels of borrowing and spending by Government and the need to rebuild public finances in the future.
The risk of raising taxes too soon into the post-pandemic recovery is that it saps the strength of the recovery. I believe there is bound to be a surge in consumer spending as individuals and families enjoy their freedom from lockdown to shop, eat out and holiday. But it won’t be until well into 2022 before we know the full scale of the likely bankruptcies to come, the peak levels unemployment will reach – today’s more upbeat forecast notwithstanding – nor the longer-term psychological impact on consumers of the pandemic on spending and saving habits.
Crucially, though, the Chancellor needs to remember the lesson of all his predecessors in the depths of a recession. The cyclicality of Government finances means that as the economy recovers, automatically Government spending will fall and tax receipts will rise. The end to Government support measures and a resumption of consumer spending will boost VAT receipts just as the support cheques cease to be written; in this regard, I believe the transition measures announced today are to be welcomed.
Clearly though, one of the most significant of today’s announcements is the planned increase in Corporation Tax as of April 2023 from the current 19% to 25%. While this does indeed give businesses clarity, it is nevertheless a substantial increase, which will in time impact on companies’ ability to return profits to shareholders, and at variance with widely held expectations that such hikes would begin sooner and would be more gradual in their introduction.
Investors will be considering the impact of this pending rise and will be asking themselves to what extent it can be offset by the generous-sounding 130% “super deduction” on business investment. While this is, in my view, an innovative and progressive policy, taken together with the upcoming rise in Corporation Tax, it is likely to mean that the economic growth benefits resulting from the policy will be somewhat front loaded.
Meanwhile, the decision to maintain income tax, National Insurance and VAT at their current levels should provide some support consumer confidence and household budgets as the country emerges from the pandemic. Nevertheless, the Chancellor’s explicit announcements of upcoming fiscal drag – the result of not adjusting taxation thresholds to take account of future inflation – reflects the reality of the situation of the post-pandemic economy. Although this is undoubtedly a progressive policy, put simply, the higher inflation rises, the more the Treasury is likely to benefit. Over time, should we enter a more inflationary environment, in public finance terms this may well turn out to have been a prudent decision, given the impact of rising inflation on the cost of servicing our national debt.
Turning to the UK equity market, it was no surprise to see rising share prices among those businesses that should be beneficiaries of further support to the domestic economy, such as banks and leisure stocks, alongside housebuilders. The latter may well benefit from the extension of the stamp duty holiday and mortgage guarantee programme, as well as a more benign backdrop through the extension of Government support through the summer’s transition from lockdown and re-opening to the end of measures such as the furlough scheme.
Looking to the longer term, to my mind, the truly prudent but wise Chancellor will not risk the upturn by setting out a plan for increased taxation in the years ahead, but keep his powder dry to see just how radically Treasury finances improve over the coming year, without any action on his part whatsoever. While today’s Budget announcements appear well placed to support the transition to life after the pandemic over the next couple of years, it remains to be seen whether the “front-loading” of business incentives to spend now but be taxed later leads to a slowdown in growth thereafter which might not have been necessary.
Sunak’s balancing act as stars align for UK
Dan Nickols, Head of Strategy, UK Small & Mid Cap, reacts to the 2021 Budget.
The balancing act for Rishi Sunak in today’s Budget was to avoid choking off economic recovery through premature tax rises, while also demonstrating that he is serious about addressing the UK’s public finance challenges at the appropriate time. I think he achieved that, and the market reaction to these widely trailed policies has been sanguine so far.
The rise in corporation tax scheduled for April 2023 (i.e., fiscal year 2023-2024), is sufficiently far in the future to allow business to recover before their tax bills go up, while continuing with the policies that many people depend on, such as furlough, the self-employed grant, and the extension to higher universal credit, allow households a little additional respite.
It was clear that the government is not backtracking on its levelling up agenda across the country, and if anything are doubling down on that through initiatives such as the UK Infrastructure Bank to be based in Leeds, and the freeports. The “super deduction” for business investment is also an interesting innovation that, if the economic theory proves correct, should have a meaningful positive effect.
The announced upgrade in economic growth forecasts for the UK from the Office of Budget Responsibility – which now predict 4% growth this year and 7.3% next year – point to something that I’ve been saying recently: that the stars are aligning for the UK. Our vaccination programme is outstripping that of most other countries, with over 20 million people now having received their first dose and the rollout set to accelerate in the coming weeks. If the target of all adults in the UK being offered a vaccine by the end of July is hit, and with social restrictions currently scheduled to end in mid-June, it is easy to feel optimistic about the prospects for both the UK economy and its stock market in the second half of this year.
There are number of other factors that give reason for confidence. For example, the UK’s savings rate (the proportion of income saved rather than spent) is very high by historical standards at the moment because so many avenues for spending have been closed, but those additional savings should help fuel a bounce as the economy opens up again.
Looking at smaller companies in the UK, which is my speciality, it’s also a sign of health that new stock market listings have been on the rise after a few quiet years. The publication today of Lord Hill’s UK Listing Review, which makes recommendations designed to make the UK an even more attractive destination for companies to list, points to further progress on that score.
Taken together, in my view all these factors materially outweigh the risks to the UK economy, such as potential trade friction due to Brexit, over at least the short term. I feel the stars are aligning for the UK, which is an increasingly positive place to be invested.
Jam today … bee sting tomorrow
Harry Richards and Adam Darling, fund managers, fixed income, share their insights into chancellor Rishi Sunak’s 2021 Budget.
Overall, Rishi Sunak’s 2021 budget was much as expected, with the chancellor offering jam today, but with the prospect of a bee sting or two tomorrow. In effect, the chancellor continued his support of the UK’s COVID-damaged economy, recognising that it is not out of the woods yet; but he also paved the way for the future tax rises that he views as the necessary way of paying for it all.
Faced with the difficult balancing act of protecting and supporting the UK economy while not relinquishing all claims to fiscal responsibility, Sunak has done a reasonable job, in our view. It would be churlish to accuse him of adopting an Augustinian view: God make me fiscally responsible, but not yet. He is doing the best he can in unique circumstances.
In particular, we applaud the Bank of England’s commitment to “reflect the importance of environmental sustainability and the transition to Net Zero”, that is, the reduction in carbon emissions required to limit global warming to levels aligned with the Paris Accord. We shall watch with interest whether this changes the range of companies the Bank of England is prepared to support with corporate bond purchases. It is emblematic of how central bank involvement is evolving and we have seen a similar drive from the European Central Bank in this same direction. In our view, this could further pressure valuations in bonds across some of the sectors that are seen as more challenged from an ESG (environmental, social and governance) perspective. We expect the Bank of England to remain broadly accommodative in supporting the ongoing fiscal splurge, with government borrowing needs being revised higher in the short term.
We also welcome Sunak’s imaginative encouragement of capital investment by companies with his ‘super deduction’ measures. This is a valiant attempt to encourage productivity at a fundamental level. We also welcome Sunak’s introduction of eight freeports.
The much-leaked rumours of tax rises to come set the scene for today. The planned hike in corporate tax rates, from 19% to 25%, will only fall on the 10% largest companies, which we also see as a sensible move. We also note that the pain of this tax hike is delayed for two years, until April 2023. In our own investing practice, we have long avoided companies with the sorts of stretched finances that would be unduly damaged by such an increase. We have long been very cautious about aggressively indebted companies, which always remain vulnerable to changes in underlying macroeconomic and tax conditions. The freezing of earnings thresholds for personal income tax will effectively increase the amount of tax the consumer pays over time, but will only kick in from next year. Rumours of an online sales tax or changes to the treatment of capital gains did not materialise, but we note that discussions are ongoing – we may expect to see further tax changes over the course of the year depending on the evolution of government finances.
We would caution more broadly that credit market pricing, in common with a lot of other assets, seems to be reflecting the rosiest of scenarios. The prevailing narrative assumes an appealing mix of improving economic conditions as the world reopens through successful COVID vaccination, combined with ongoing emergency levels of fiscal support and central bank accommodation, and no significant macro-economic shocks of any kind. Optimism is fully baked into a lot of current valuations. While we understand the narrative, history has taught us that market complacency can be dangerous. Sunak’s budget, and the recent global volatility in government bond yields, highlights that there may be pain to come and that the world has to adjust to a very different post-COVID world with significantly higher debt levels.
This budget does not in itself have massive short-term implications for sterling corporate bonds: its importance is more that it is a signal that there are limits to government support. Fiscal tightening will arrive in the future. Investors would be well advised to prepare for that now.
We believe that there remains a plethora of opportunities in the sterling corporate bond sector. In our view, sterling corporate bonds provide an excellent diversifier away from UK equities. They offer higher yields than gilts (UK government debt) and typically experience far less volatility (fluctuate less on average) than UK equities (shares in companies).
When managing money, we focus on preservation of capital, an attractive yield, and risk adjusted returns. We concentrate on the most liquid bonds, that is, those that are relatively easy to trade in the market. This means we generally invest in bonds of larger size, as these tend to be the most liquid. We believe that sterling corporate bonds offer active fund managers the scope to add value through judicious selection of companies and a willingness to be flexible.
Please note: Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.
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