Tax, debt and spending, the UK way

Tax, debt and spending, the UK way

Just in case you haven’t had enough of the UK budget, here are our thoughts on last week’s statement.

• First, it cheered the government bond market. A surprise increase in the size of the fiscal headroom – the margin of error for meeting the government’s debt reduction target - from £10bn to £22bn, helping push down the cost of government borrowing last week. Yields on UK ten-year government bonds saw their best ‘budget-day’ performance in 20 years.

• Second, greater headroom eases but doesn’t solve Britain’s debt problem. £22bn of headroom is less than set by previous chancellors and gives Ms Reeves just a 59% chance of meeting her fiscal rule, according to the Office for Budget Responsibility. In any case, meeting the fiscal rules would scarcely put a dent in the build-up of UK public debt, levels of which have nearly tripled since 2005. The budget forecasts that the ratio of net debt to GDP will end this decade close to an 80 year high. Last week’s gilt rally needs to be seen in the context of the UK having, since February, the highest borrowing costs of any G7 economy.

• Third, the chancellor has foresworn austerity and committed the UK to historically high levels of government spending. In her two budgets Ms Reeves pledged about £80bn of extra public expenditure. Public spending is set to run around 44%-45% of GDP through the rest of this parliament, levels never seen outside recessions and wartime.

• Fourth, last week’s £26bn of tax rises, together with last October’s £40bn tax increases, amount to about 2% of GDP - a bigger tax increase than seen in any parliament since the 1980s. By the end of this parliament taxes are forecast to account for 38.3% of GDP, the highest level since comparable records started in the early 1950s.

• Fifth, the budget is unlikely to do much directly to boost growth. Richard Hughes, chairman of the OBR, said last week that none of the chancellor’s measures met the standard needed to raise the OBR’s growth projections. (The OBR has assessed previous government plans for investment, infrastructure and planning reform as being positive for growth). In the longer run, a rising tax burden seems likely, if anything, to weigh on growth.

• Sixth, last week’s cost of living measures, including freezing rail fares and lowering energy bills, will reduce inflation by about 0.4% next year. Inflation peaked in September at 4.0% and by the middle of next year is likely to be running at around 2.0%. Lower inflation is likely to pave the way for further interest rate reductions. We think the Bank of England will cut interest rates by 25bp to 3.75% at their next meeting on 18 December and by a further 25bp next spring.

• The budget sets a course for higher public spending and higher taxes in a way that has, for now,  steadied the bond market. Falling inflation and lower  rates should help bolster activity. In the longer term, a rising tax burden and high levels of public debt pose their own very real risks.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 1.9% and the US S&P 500 equity index rose by 4.5% as investors increased bets that the Federal Reserve will lower interest rates in December.

Economics

• Global transactions valued over $10bn reached a record this year of 63, according to LSEG, driven by pent-up demand for mergers and acquisitions and US president Donald Trump’s deregulatory drive
• US consumer confidence deteriorated by more than expected in November, according to the Conference Board, amid increasing concerns over rising inflation and the recently ended government shutdown
• The UK government announced plans to soften its workers’ rights legislation, including reducing the qualifying period for unfair dismissal protection from two years to 6 months of employment, instead of the original proposal of protection from day one
• UK net migration fell to 204,000 in the year to June, the lowest level since COVID-19, driven by a large fall in arrivals and higher numbers of people leaving the UK
• Up to 3m UK jobs in occupations such customer service and administration could disappear over the next decade if existing trends continue, largely due to AI and automation, according to the National Foundation for Educational Research group
• UK vehicle production fell 31% in October compared with the same month last year, according to the Society of Motor Manufacturers and Traders, as Jaguar-Land Rover began to restart production following a cyber-attack
• German business sentiment deteriorated in November, according to the ifo Business Climate survey, due to more pessimistic expectations. The ifo Institute commented that businesses “have little faith that a recovery is coming anytime soon”
• Canadian prime minister Mark Carney unveiled plans for a new oil pipeline from the country’s oil fields to its west coast in attempts to pivot to Asian markets and reduce reliance on the US

Business

• JP Morgan unveiled plans to build a new office tower in Canary Wharf in a boost London’s financial district
• The UK government announced plans for oil and gas companies to drill new oil fields that are adjacent to existing fields and link to existing infrastructure, in a move to improve the UK’s energy security
• Large Chinese technology companies are training AI models overseas to avoid the US governments efforts to limit the export of chips produced by US tech giant Nvidia to China, the FT reports
• German car manufacturer Volkswagen said it is able to develop and produce cars in China at up to half the cost of developing them in Germany, due to supply chain and procurement efficiencies and shorter development times
• Craig Peters, chief executive of Getty Images, said that the US-listed visual content group would reconsider its UK operations if a merger with rival Shutterstock was blocked
• Italian defence company Leonardo unveiled an air-defence technology that would enable a missile-shield system, named the “Michelangelo Dome”, that would operate in a similar way to Israel’s Iron Dome 

Global and political developments

• Russian president Vladimir Putin downplayed the US’s recent peace proposal between Russia and Ukraine, ahead of planned meeting this week between US and Russian officials. Mr Putin said Russia would only stop fighting in the Donbas region if Ukraine withdrew its troops
• Belgian prime minister Bart De Wever warned that using frozen Russian assets to fund Ukraine would damage the chances of a potential peace deal, the FT reports
• The Ukrainian government’s chief of staff Andriy Yermak resigned following a raid on his house by anti-corruption officials 
• Mr Trump threatened to “permanently pause migration” from multiple countries and “remove anyone who is not an asset to the United States” following an attack on two National Guard members
• Mr Trump said he would bar South Africa from attending the G20 summit next year and would immediately stop US subsidies and payments to the country, marking the latest escalation in tensions between the two leaders
• Swiss voters overwhelmingly rejected a proposal to impose a 50% inheritance tax on the super-rich
• The Office for Budget Responsibility hired cyber security experts to investigate how its Economic and Fiscal Outlook document, which provides details of the UK government’s budget plans, was released early. It is expected that the incident was a “straightforward data-handling mistake”, according to expert Patrick Burgess
• French president Emmanuel Macron announced plans introduce voluntary military service for young people as part of plans to increase France’s defence capabilities against rising threats from Russia

And finally… Jamaica won its first ever gold medal in bobsledding at the North American cup last week. The Caribbean island has  forged a notable presence in winter sports -  Cool Runnings