First, the UK Budget
Occasionally, the economic, political and fiscal backdrop to a Budget are aligned. That is, the economic and political needs from the Budget are similar, while the fiscal numbers allow these to be met. This Budget, however, is not one of those occasions.
There is some overlap between the economic and political needs. Both suggest the case for a fiscal boost, but the budgetary sums limit the room for manoeuvre.
As a result, it has been important for the Chancellor to manage expectations ahead of the Budget. While market and public attention will be focused on what he does, as opposed to what he says, one would expect the Chancellor’s Budget speech to stress the economy is turning the corner, inflation is falling and the public finances have stabilised.
The Chancellor's political need will be to provide as big a fiscal boost as allowed, with his focus being on tax cuts – and also to keep open the option of allowing scope to repeat the process in the autumn, if needed. While a general election in May is possible, it seems unlikely. The expectation is that it will be later in the year, but if there is to be another fiscal event then it would most likely have to be in October with an Autumn Statement.
That would be consistent with an election in November or December or even January 2025, and after the result of the US election is known. Perhaps given all the complexities, the Chancellor should just assume he will only get one bite this year and that is in this Budget.
Economically, there is a strong case to provide a fiscal stimulus now, as demand is sluggish and inflation easing.
Because of the fiscal rules the market’s expectation is that the fiscal boost in this Budget will be small. The two main rules signify that the ratio of public debt to national income is heading lower after five years and that also by then, the budget deficit is less than 3% of GDP. Both these rules were just met in the Autumn and that is likely to be the case now.
As the current level of debt is high, prospects for economic growth and interest rates become critical for calculating the Chancellor’s fiscal space – hence the critical role of the Office for Budget Responsibility’s forecasts. If economic growth forecasts are low then more of the budget deficit is viewed as structural, not cyclical, and this limits the fiscal room for manoeuvre. The OBR takes the market’s interest rate views, which point to only gradual cuts as the year progresses.
The current economic context shows a weak economy but one likely to improve this year. A technical recession was recorded at the end of last year, with two successive quarters of negative growth, but the economy should show modest growth this year – as wage growth outstrips inflation, the unemployment rate stays low and, as the year progresses, interest rates fall. In my view, there is a case for an immediate interest rate cut, as monetary policy has moved from too loose to too tight.
The likely Budget boost may be small but not insignificant. After the first ten months of this fiscal year the budget deficit was £96.6 billion and while high, it is £9.3 billion better than official forecasts, and the market consensus is that this will allow £15 billion of fiscal space.
Last year both the Chancellor’s fiscal events were stimulative. He provided a £93.7 billion boost in the Autumn Statement, based on the impact of his announcements up to 2028/29. That followed a similar boost, over five years, of £91.3 billion in the March 2023 Budget. These followed a £131.3 billion tightening in the autumn of 2022. The two main measures last autumn were welcome, namely full expensing for companies (due to cost £10.9 billion a year by 2028/29) and cuts to national insurance worth £10 billion by the same fiscal year. When one considers the annual costs of such measures, alongside the amount of fiscal space the Chancellor has in the Budget, one can see there is limited scope for headline grabbing measures.
For there to be more, the OBR needs to expect growth to be higher. Additionally, if the Chancellor wanted to create more space for the tax cuts that he appears to favour, he would have to squeeze future spending plans further. This remains an option, yet the current consensus is that existing expenditure plans are already tough and there is scepticism as to whether they will be met, whoever wins the election. There has been much speculation that the Chancellor could raise taxes in some areas, to create scope for a tax cut he favours, such as another reduction in national insurance.
Hence, as was the case last Autumn, the Chancellor will look for supply-side measures that are fiscally neutral to help growth. Unfortunately, politics has already held back one of the key ones, namely easing planning reform, and this is not going to be corrected in this Budget. Measures to help the competitiveness of the City and financial sector have been a welcome feature of policy in recent years. Also, there could be a further strengthening of measures to help people save, either to buy a house or for their pension. For a vast array of people, the cost of housing and of childcare are expensive and measures to help address either would be timely.
Too often tax policy is talked about solely in terms of tax cuts. It is more than that. Tax reform is needed. In any discussion on tax it is always worth noting Adam Smith’s four principles of tax – as these have stood the test of time: fairness, efficiency, certainty, plus simplicity or convenience to collect. Incentives matter. Taxes should not distort economic behaviour and not discourage growth. Clearly one needs taxes (as well as borrowing) to fund the state but too often now they are solely seen as raising revenue and not encouraging economic activity or changing behaviour. Thus, the future trajectory is seen as up.
It goes without saying that public services need to be funded properly but the wider impact of many taxes needs to be considered. For instance, the impact of stamp duty on discouraging turnover, whether it be in housing or the stock market. Thankfully we have a very progressive tax system, although this, too, creates difficulties as it means tax cuts tend to help those who are better off. This often means politics not economics drives the debate – as we continue to see.
For instance, the issue of indexation and fiscal drag, where higher inflation drags people into higher tax brackets as allowances do not rise in line with inflation. While it would be economically welcome to correct this, it would be costly and not possible now. Tax simplification, too, is needed as there are so many reliefs and allowances, and frequent fiscal changes. Last March’s 2023 Budget saw 84 fiscal measures, many small, while the Autumn Statement witnessed 67. This is far too much meddling. Taxes, moreover, must be seen as just one part of a broad-based economic strategy.
In terms of the government’s finances, the options at any time are: economic growth, borrowing, curbs on public spending or even austerity (although that didn’t work a decade ago in the UK and made little economic sense at the time), higher taxation or reform of public services and the economy. Currently debt levels, borrowing, public spending and the tax take are all high.
One could say the economics suggests a fiscal boost. The politics will decide where this will be directed (small tax cuts), but the fiscal rules will limit the scope. Of course, if the fiscal numbers only permit a limited boost in the Budget this might bolster the case for interest rate cuts. The smaller the fiscal boost the more likely that interest rate expectations and bond yields will ease after this Budget, although it is still expected that the first interest rate cut will be in late Q2.
Second, China’s Two Sessions
China’s Two Sessions in early March is, as always, a pivotal event, especially with respect to economic policy. The three main highlights of the Two Sessions are the President’s speech, the press conference of the Foreign Minister and the opening work report by the Premier, in which the economic focus is outlined.
In mid-December 2023 China’s annual Central Economic Work Conference (CEWC) took place, outlining the headline economic priorities for the year ahead. These will be endorsed at the Two Sessions, with further details, including the economic growth target for the year ahead. This is expected to be around 5%. The priority areas outlined by the CEWC will be endorsed, such as expanding domestic demand and encouraging further innovation and development to move towards “a modern industrial society”.
China is already moving towards a significantly slower future trend pace of growth, alongside a declining population, and this adds to the pressure to improve the quality of economic growth by moving up the value-curve, boosting innovation and investment.
Noteworthy in the wake of December’s CEWC, from a financial market’s perspective, was the policy aim to strengthen counter-cyclical and cross-cyclical macro-policy. This included implementing proactive fiscal policy and prudent monetary policy, plus strengthening innovation and coordination of policy tools. There has been some monetary easing since, but fiscal stimulus has been limited and looks likely to remain so, given ongoing concerns about the scale of the debt overhang in the property sector and among local government. Now, with the economy sluggish, pressure for a fiscal stimulus will grow and one area of focus in the Premier’s speech will be his guidance on fiscal policy.
At the start of CEWC, meanwhile, the priorities outlined were social development, policy continuity, economic stability and addressing investor confidence. Since then economic data has confirmed a problem that the State Council drew attention to last August, when it issued a range of ideas to boost foreign direct investment. Recent data released by the State Administration of Foreign Exchange was that net foreign direct investment into China was $33 billion, down for the second successive year, and compared with a peak of $344 billion in 2021. Indeed, previous data had shown the first ever net outflow in Q3 last year, but this was reversed in Q4 back to a net inflow.
The other noteworthy recent data was that inflation fell by 0.8% in January. Although inflation is in negative territory, it is premature to suggest China is in deflation. Output would be falling, too, if that were the case. Nonetheless, the combination of sluggish demand and an absence of inflation, strengthens the case for policy easing.
Recently one of the messages highlighted has been the need to prioritise development before addressing problems, and that may be repeated. If so, the markets will conclude that it will be predictable policies, including modest policy easing and further reforms aimed at steady growth this year.
Disinflation
Finally, another key focus in March will be to assess the latest inflation data in western economies. This is an issue we have covered in detail before so I will not dwell on it here. Suffice to say this will help markets gauge disinflationary pressures and how this might impact the timing of interest rate cuts. Inflation is decelerating and policy rates will need to fall.
Please note, the value of your investments can go down as well as up.
