This will be a Tax, Borrow and Spend Budget. I expect two major components: one being a change in the definition of debt, from Public Sector Net Debt (PSND) to Public Sector Net Worth (PWNW) that will permit higher borrowing to fund public investment; and second, increased taxes to fund higher public spending, focused on the NHS.
The Budget is titled, “Fixing the foundations to deliver change”. The narrative underpinning this is likely to be that higher public investment is necessary to secure the green transition to net zero and to deliver strong, sustained growth, and that higher taxes are necessary because of the public finances and the need to spend more on public services. Also, it should be noted that this is a one-year Spending Round and thus many of the issues linked to future spending will still need to be addressed, especially in non-ring-fenced areas where spending pressures may be more acute.
I have long been an advocate of a pro-growth economic strategy, that UK investment is too low, particularly on R&D and that we needed to scale up our infrastructure, with increased public investment. Thus, the growth orientated component of this Budget focused on boosting investment sounds promising, although one needs to see the details. Increased public investment looks set to be linked to the green agenda, while addressing the need to reduce high energy costs.
Addressing low investment should include incentivising the private sector and requires the City and banks to close funding gaps, such as the lack of long-term patient capital and lending to small and medium-sized enterprises. Over half the economists responding the FT’s January survey cited lack of planning reform as holding back growth. I was one of them. I also felt institutional change was needed too. Alongside the Budget, planning reform seems likely.
The economic backdrop
The economy is growing modestly, and while it is not in great shape it is not as poor as much of the recent pre-Budget political narrative has painted. Indeed, in their latest economic forecasts released this week, the International Monetary Fund (IMF) sees the UK as the strongest performing of the four major western European economies, with growth of 1.1% this year and 1.5% next. In comparison the IMF sees 0.0% and 0.8% for Germany, 0.7% and 0.8% for Italy and 1.1% for France both this year and next. This is in the context of subdued global growth of only 3.2% in both 2024 and 2025, although low inflation should allow scope for global interest rates to fall.
At the time of the March Budget the Office for Budget Responsibility (OBR) was relatively upbeat about the economic outlook and they should be given credit for that. Then, the OBR was forecasting 0.8% growth for this year and 1.9% next. In contrast, at that time, the Bank of England was forecasting only 0.2% growth for 2024 and the Treasury’s comparison of independent forecasters was pointing to growth of 0.4% for 2024 and 1.2% for 2025.
Now, independent forecasters are predicting 1.0% growth for 2024 and 1.3% for next year. Thus, a solid economic performance was already factored into the fiscal numbers in March. The OBR’s economic outlook of modest growth, plus their factoring in the market’s expectation that interest rates could fall from 5% now towards to a terminal rate of 3.7% later next year, will likely create some fiscal space for the Chancellor.
The OBR will also factor in the economic impact of the Chancellor’s policy actions. However, the positive impact of increased public investment will take time to feed through, with the OBR assuming each one per cent of GDP permanent increase in public investment will boost growth by 2% after ten to fifteen years. In contrast, any fiscal tightening would likely dampen growth prospects near-term.
The fiscal numbers
While the economic performance is better than the political narrative suggests, the fiscal numbers, in contrast are poor.
The Budget could see a significant change in the target measure for the public finances. Currently, we look at these in terms of debt and liabilities, with targets announced for Public Sector Net Debt (PSND).
A change to the balance sheet definition of debt is expected, which includes assets as well as liabilities. Enthusiasm for this is based on the view that public investment is low and that you should take note of the asset created. A switch is expected from PSND to Public Sector Net Worth (PSNW), which includes financial and non-financial assets and liabilities. This is more than just a technical change. For a start, it could transform the Chancellor’s options in the Budget. Moving to PSNW may allow around £50 billion of fiscal space.
While investment creates an asset, you still have to finance the liability. Higher borrowing points to increased issuance of gilts – and thus the need for yields to be high or attractive enough to entice investors. A balance sheet approach doesn’t get away from the need to fund the deficit and keep investors and financial markets on side. Thus, it is vital the markets see her plans as credible. It does not mean that the Chancellor needs to borrow immediately, but it creates the space to do so.
In addition to a change in the definition of debt, some tweaking to the fiscal rules is always possible. The main ones are a budget deficit below 3% of GDP and debt falling as a share of national income in five years time. Moving to a balance sheet approach could also see a new rule, such as a net worth objective to improve as a share of GDP over time.
In September, the ONS reported that, “Public sector net debt excluding public sector banks was provisionally estimated at 98.5% of gross domestic product (GDP) at the end of September 2024… and remains at levels last seen in the early 1960s. Excluding the Bank of England, debt was 91.2% of GDP.” While, “Public sector net worth excluding public sector banks was in deficit by £731.3 billion at the end of September 2024, a £128.4 billion larger deficit than at the end of September 2023.”
Although much of the present debate is about how this will allow scope for higher public investment, it could – with the right focus – be a stepping stone towards a greater focus on improving the quality as well as controlling the quantity of public sector expenditure. But for now, it adds to the debt burden.
The second major component will be higher taxes. After the March Budget, the official data, as the OBR pointed out, personal taxes paid by a median earner (with no children and no interaction with the benefits system) as a share of their income in 2024/25 are at their lowest since 1975, when the modern structure of national insurance came into effect. The plans in the March Budget pointed to tax as a share of income rising to 37.1% in 2028/29, four per cent higher than pre-pandemic. Additional changes in this Budget could push that figure higher.
The financial markets have already anticipated the economic narrative and policy aims associated with this Budget. The key now is to see the fiscal and economic numbers, and how they add up. It is unlikely that the Budget will change fundamentally the outlook for interest rates, and against a backdrop of subdued inflation the markets will expect interest rates to fall significantly further.
Please note, the value of your investments can go down as well as up.
