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When the Chancellor delivered his fifth budget speech in Parliament the tone was fiscally
neutral but some commentators believe that some of the proposals had a very clear end
objective politically. This is hardly surprising given that the next general elections are
about a year away. There was an element of chest thumping, perhaps justifiably so. For
the first time in his tenure as Chancellor George Osborne was delivering the budget against
the backdrop of an improving macroeconomic environment. The politically independent office
for Budget Responsibility, the OBR, has revised up its forecast for growth for 2014 and 2015,
as a result on current estimates the economy is expected to achieve its pre 2008 stature
sometime within the latter half of 2014. There were four key policy initiatives - One - a
continuation of the fiscal consolidation begun in 2010. Two - a beginnings of a policy led
effort to improve the structure of the economy through export growth. Three - supplier side
initiatives to support infrastructure development and incentives for businesses to increase
investment spending. And finally and perhaps most unexpectedly radical and far reaching
reform to the savings market particularly the segment aimed at the elderly and or the
at or near retirement age populations.
First - policy continuity. Using independent estimates of the OBR the Chancellor was able
to demonstrate that the path to fiscal consolidation, as contained in the original 2010 blueprint,
may have had some delays but the directional intent remained intact. Underlying public
sector net borrowing or PSNB which hit its peak in 2009 to 10 at eleven per cent of GDP
is expected to half to five point five per cent of GDP during 2014/15 and then expected
to continue downward until a small surplus is achieved in 2018/19. As a result, overall
government indebtedness is expected to peak at 78.7 per cent of GDP in 2015/16 before
turning lower and ending at 74.2 per cent of GDP in 2018/19 which is the end of the
OBR's forecast period. Given the OBR's growth forecast however what this actually means
is that the improvements in the fiscal deficit position are largely cyclical. Structurally
the imbalance in the public finance position remains pretty much where it was at the time
of the original OBR estimates. Speaking of the growth forecasts the story right below
the surface of the OBR's superficial good news remains somewhat sobering. The composition
of a recovery is still unbalanced and heavily reliant on ongoing household consumer spending
and the property market. While business investment is expected to improve the OBR does not expect
it to reach its pre 2008 level as a percentage of GDP over the forecast period of five years.
Given this mismatch between the growth in the economy and the growth in the supply capacity
of the economy the OBR expects the output gap which is the slack between where the economy
is currently operating and where it could potentially operate to narrow and ultimately
close out by sometime in 2018 thereby putting a sort of lid on potential growth towards
the back end of the forecast period.
The Chancellor would argue that some of the proposals in his budget are aimed at addressing
precisely these concerns around the outward gap. So let's take a look at some of the key
proposals. Exports - The increase in the export finance facility to three billion pounds sterling
and a concomitant reduction in the interest rate charged by a third will certainly help.
The export sector can certainly use all the help it can get with a strong pound sterling
and its largest market, the eurozone, still not completely out of the woods. This support
will be welcome. Similarly the proposal to double the investment allowance for companies
to 0.5 million pounds sterling has been welcomed by the Confederation for British Industry
and should provide incentives for businesses to increase their investment spending.
On spending too the Chancellor has stayed close to his conservative roots with a hundred
and nineteen billion pound sterling cap on total welfare spending. The Chancellor will
be hoping that the cumulative effects of these welfare spending reforms, as well as a substantial
squeeze on government departmental spending will reduce the stake of government activity
in the overall economy to its lowest since 1948 over the forecast period as the OBR predicts.
The crux of the budget however has to be the quite radical reforms proposed for the savings market
especially that segment aimed at the elderly and near retirement demographic. There are
two key elements to this reform to the savings market - 1 - that annuities will no longer
be mandatory and 2 - a relaxation in the rate of tax charged on above threshold withdrawals
from the pension pot. I expect the net effect of this will be A - increased flexibility
for the long term savers and B- potentially increased revenue for the treasury as lower
tax rate encourages more above threshold withdrawals from the pension pot. Further reform to the
ISA market, the popular individual savings account market are also being seen as saver
friendly. Erstwhile separate cash and stock ISAs are to merged into a single, new ISA
with an enhanced limit of £15,000 sterling annually. Let's put this in perspective - the
annual limit on the cash ISA is £5,760 and the annual limit on the stock ISA is £11,520.
I believe this represents a significant improvement in terms of the opportunities available to
regular savers both in terms of the overall quantum as well as the flexibility that the
new ISA affords them. Additionally the Chancellor has proposed new tax deductions which I think
will have the net effect of improving household finances. There are three key elements to
this - 1 - is the improvement in the personal allowance, 2 - the elimination of the 10%
tax on small savings and 3 - the enhancement in the threshold rate for the higher rate
of tax. Collectively I believe that this will put more money back in the hands of the households
and enhance the flexibility with which they can save, spend and invest their own earnings.
Incrementally these may look like small changes but I believe that over the long term these
could have profound implications for the retail banking market as well as the long term savings
market.
Equity markets fell by 0.5 per cent during and immediately after the Chancellor's speech
driven down quite likely by a selloff in insurance sector stocks as investors discount the likely
damage to come to insurance companies' financials from the loss of the pension annuities business.
In the currency markets the pound sterling maintained recent strength during the course
of the Chancellor's speech and even rose slightly towards the end. Investors here were quite
clearly giving a thumbs up to the budget. Bond markets too showed a pretty sanguine
response. The yields of the ten year gilt rose and then fell during the course of the
Chancellor's speech ending the day virtually unchanged.
Much of the policy direction in the Chancellor's budget speech was either a continuation of
past policy intent or reasonably well flagged and well signalled new policy initiative with
the exception of the quite notable and remarkable savings market reforms. The budget does not
materially alter our outlook for the UK economy or for pounds sterling denominated assets.
UK equities and UK property remain two of our top four asset classes in terms of forecasts,
twelve month returns and we remain constructively exposed to them.