The Chancellor’s budget came and went with most of its contents having been well-trailed. The government’s finances are a mess thanks to the pandemic. What will have amounted to a fifteen-month episode will take decades from which to recover fully, not so much in terms of GDP, but repairing and de-risking the national balance sheet.

 

Given the Covid unlock timetable announced by Boris, the political expediency for delaying the termination of the ‘extend-and-pretend’ business and employment lifeboat schemes was inevitable. Just as inevitable was Mr Sunak’s declaration that now is not the time to stint on national expenditure (any hint of ‘austerity’ and all its attendant baggage in the aftermath of the global financial crisis is pregnant with political reputational risk), but equally that the bill must be paid sometime. It will be those with the ‘broadest shoulders’ who should bear the brunt. The bulk of the cost falls on business; while companies are certainly being incentivised through tax offsets to invest, it was nevertheless a triumph of chutzpah, of political bravado, to be able to present a 31.6% or six-point increase in the rate of corporation tax from 19% to 25% delayed to April 2023 as a victory for businesses over their international competitors. Already boxed in by manifesto promises, his announcement to freeze personal taxation thresholds and reliefs was about the only way of increasing the nominal tax take from individuals without increasing headline National Insurance and Income Tax rates.

 

However, in addressing the fundamental problem of the government deficit, which in essence boils down either to securing more income (taxes and duties) or spending less, the Chancellor is far from finished with us yet. On March 23rd, dubbed Tax Day, he will unveil a consultation paper on tax reform, ostensibly designed to simplify tax structures and the means by which taxes are collected. As was a subject of conjecture last summer, the rate at which Capital Gains Tax is levied is likely to fall under the spotlight, again facing the suggestion that under the seductive cloak of ‘simplification and harmonisation’, taking CGT rates to the individual’s marginal rate of income tax is an appropriate reform. No doubt there will be others. Between business and individuals, in the post-Covid world we all have a debt to society and that debt is explicitly enduring; one way or another, we will all pay but investors who have had the benefit of a decade’s worth of one-way markets effectively underwritten by central bank QE may yet be singled out for special treatment.

 

Monetarist economists would suggest that much the soundest way to rebuild both the economy and the government finances is through economic growth, a belief they see supported by the incentive of low taxation. They believe that individuals’ discretion over personal expenditure and the private sector’s capital allocation choices are more efficient than the blunt tool of government spending when building sure economic foundations. Clearly, having explicitly declared the intention for the state’s participation to be the biggest in generations, this is not a belief shared by the Chancellor. In that context it was therefore interesting to hear the independent Office of Budget Responsibility’s (OBR) five-year economic forecasts. After the 9.9% GDP collapse in 2020, the OBR sees 4% recovery this year reflecting a significantly disrupted first half followed by the benefit of unlock after June 21st; 2022 should see a full year of recovery with expansion of 7.3%, the Bank of England’s ‘coiled spring’ waiting to unleash its ‘pent-up energy’. Thereafter, the OBR estimates UK growth patterns continuing at a stable rate of sub-2%, satisfactory but hardly setting the pulse racing. Higher taxes, not long implemented; relatively pedestrian growth rates resuming: something of a challenge for an incumbent government facing a general election in 2024! One for another day.

 

Thursday saw the regular US Federal Reserve policy meeting held against the backdrop of the much discussed, steady upward pressure on US sovereign bond yields. Chairman Powell reiterated his guidance: there is still a long way to go to restore economic fortunes; he is not much worried about ‘transitory’ inflation pressures; he does note and warn against the debilitating effect of investors pushing up financing costs by forcing bond yields higher, but is not minded to react. Quite probably he has filed away at the back of his memory the episode at the turn of 2019 when, among other factors, market movements helped force a very abrupt 180-degree U-turn in interest rate policy, quickly dubbed “Powell’s Policy Pivot”, a soubriquet he is yet to live down and is in no hurry to earn again. As bonds reacted by promptly adding another 0.1%, taking yields to in excess of 1.5% (having been 0.3% 11 months ago and with interest rates static at zero percent), this is developing all the hallmarks of a growing Mexican stand-off between the central bank and fixed income investors. Who really determines US interest rates? The Fed? Or the market? It cannot be both. Time will tell who blinks first and is forced to retreat.

 

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