Hunting for growth in the UK

However, it should perhaps have been called a “Hunt for Red October”, after the classic 1990 Hollywood film starring Sean Connery. Just replace the cat-and-mouse tactics of submarine warfare with political warfare of the major political parties. The Chancellor (and PM) clearly has an eye on the election that we predict will occur in the autumn as he is keen to eliminate the risk that the next government turns Labour red, rather than Conservative blue.

The main headline from the budget was a National Insurance Contributions (NIC) cut of 2 percentage points to 8% (effective from the start of the new tax year in April) for 27 million workers. This follows on from a similar cut in the Autumn Statement last November. Politically, the Conservatives will be hoping NIC cuts, and a freezing of fuel duty, can revive economic growth and popular support ahead of a general election later this year.

With limited fiscal headroom, the Chancellor funded these measures to boost growth via policies to raise tax revenues in the future. These include an extension of the windfall tax on oil and gas companies (the Energy Profits Levy) and the removal of non-domiciled tax status - flagship policies of the Labour party.

The UK stock market has underperformed other major indices so far this year. That is partly because of the low market exposure to fashionable Artificial Intelligence-led tech stocks. Overall, the consensus is that we can expect just 2.6% Earnings Per Share (EPS) growth for MSCI UK in 2024. This is much lower than the 8.7% expected for global equities, including the UK, as measured by the MSCI All Country World Index.

The budget is unlikely to generate significant UK earning upgrades, particularly as the Office of Budget Responsibility (OBR) expects real GDP to rise just 0.8% in 2024, up from 0.7% in its forecast in November. The OBR’s economic outlook for 2025 has improved though and it now predicts 1.9% real GDP, up from 1.4% previously.

The Chancellor announced a new British UK ISA that allows an additional £5,000 annual allowance to be invested in UK-listed equities tax-free. UK-based investors will welcome an increase in the amount they can shelter in the tax-free environment, but it seems unlikely this measure will be significant for the overall UK stock market given the relatively modest sums involved.

UK government bond investors will probably be relieved that the Chancellor did not go for demand-led growth by cutting income tax, which could have led to a wider budget deficit and higher gilt yields (yields move inversely to prices). The government is essentially counting on sufficiently lower wage rates and inflation for the Bank of England to cut interest rates later in the year. The OBR’s forecasts concur, showing that inflation (Consumer Price Index) is to slow from 4% currently to 2.2% in 2024 and to reach 1.5% in 2025.

Gilt investors will also cheer the fact Jeremy Hunt did not break self-imposed fiscal rules to reduce public sector net debt (as a % of GDP) by the fifth year of the OBR’s forecast. This is a stark difference to the fiasco of former Chancellor Kwasi Kwarteng’s ‘mini’ budget, also referred to as “The Growth Plan”, in September 2022 when gilt yields soared.

Slightly stronger domestic growth and adhering to fiscal responsibility rules is likely to be positively received by overseas investors. This could lift the sterling exchange rate against the US dollar through more foreign capital inflows.

Moreover, on the other side of the currency ledger, the dollar is likely to be weighed down by an improvement in the global economic outlook. The US dollar is a counter-cyclical currency, so, it strengthens in times of risk aversion and generally weakens at times of improving economic growth.

Sterling is also cheap relative to the dollar and has plenty of room to get back to its pre-Brexit level of around $1.48 to the pound in June 2016 from its current rate of $1.27.

The budget by itself is unlikely to materially move the dial on the economy or UK financial markets over the next year. However, it could have implications over the longer term if it impacts the general election result in the autumn.

Investors will then have to gauge how government policy will affect financial markets. As it stands, Chancellor Hunt will be hoping that his latest budget brings a Connery-esque escape for the Conservative party when the opinion polls currently show they are likely to lose power.