Spring Budget 2021
- 05 March 2021
- 5 mins reading time
Wednesday’s budget delivered a relatively bright outlook for investors. The economic growth picture is positive, but Chancellor of the Exchequer, Rishi Sunak, emphasised his view that the economy needs more help to recover. His approach is to continue furlough schemes, lower tax regimens and put a freeze on allowances to enable the recovery to fully take hold. Once that happens, he plans to taper and reverse the stimulus programme in order to repay the huge debt that has been built up as a result of the pandemic-led lockdowns. In the short term, this is good news for investors.
UK economy still needs help
The Office for Budget Responsibility (OBR, the independent body that provides analysis on UK government revenues and spending) has projected that the UK economy is set to grow by 4.0% in 2021 and an optimistic 7.3% in 2022. In each of the three years after that, it projects growth settling down to more familiar annual numbers of around 1.7%.
While such numbers would be welcome, the recovery is still tentative. As a result, Mr. Sunak is extending the support programme. This includes furlough schemes, tax bands being frozen, and a new tax break for businesses designed to encourage them to invest in plant and machinery.
Rising national debt
This will inevitably lead to higher government debt with a further £355 billion being borrowed this year, and £243 billion next year. That will take the UK’s total public debt to more than the country’s annual economic output.
Let’s put that into context. In 2005, the UK national debt was around £0.5 trillion (i.e. £500 billion), which equated to around 38% of the country’s annual economic output. The financial crisis which unfolded over 2007-2009, led to a rapid increase in borrowing. By this time last year, national debt was around £1.8 trillion, or 80% of annual economic output.
Today, national debt is set to exceed 100% of annual economic output which is currently around £2.1 trillion. That’s the highest level of public debt the UK has ever experienced in peacetime.
Mr. Sunak is optimistic about this situation. His intention is to generate sufficient economic growth and stability to be able to pay down the debt starting in earnest from 2023. According to the OBR, total government debt could be brought back down to pre-pandemic levels by the financial year-ending March 2026.
There appear to be two predominant channels through which Mr. Sunak intends to repay the debt.
Firstly, corporation taxes will be increased in 2023, with an emphasis on larger companies which generate healthier profit margins. Secondly, tax allowances are being kept frozen at their current levels.
Inflation and interest rates
The continued financial support over the next two years or so, seems to be a positive step in our opinion. It should help a fragile economy, which is also dealing with the implications of Brexit, to recover.
Also, economic growth is good news for long-term investors, though we would be pleasantly surprised if the economy were to deliver 7.3% next year. Either way, growth helps to support rising sales and profits which, in turn, boost share prices and enable companies to reinstate the sorts of share dividends that they were paying before the pandemic.
Growth also helps to boost inflation which the Office for National Statistics reported as running at 0.7% in January 2021. This is a long way below the generally agreed sweet spot for developed economies of around 2% a year.
That said, inflation appears set to rise over the next year or two. Central banks have indicated that they are happy for this this to go unchecked while the higher priorities of economic recovery and jobs’ growth unfold.
As a result, we don’t expect interest rates to rise in the UK before 2023 as there is sufficient spare capacity (e.g. available labour and manufacturing resources) that would need to be engaged before prices would be pushed up.
Outlook for bonds
However, we expect the recovery to be turbulent. There will be moments of concern as disappointing data come through or geopolitical developments hit the headlines.
As these events occur, the demand for and prices of bonds are likely to spike as investors seek temporary sanctuary for their money in lower-risk rated assets. What’s more, any suggestions that central banks might reduce their stimulus programmes could also affect bond prices.
This is because when interest rates go up, savings deposit accounts become more attractive. Not only are they able to increase the interest payments that they offer savers, they might also be government-backed, as is the case with bank deposit savings up to£85,000 that are covered by the Financial Services Compensation Scheme. By contrast, most bonds pay a fixed annual return even when interest rates rise.
What’s more, governments are likely to increase the volume of bonds that they issue in order to pay for the ongoing furlough schemes and other support measures.
The conclusion of all of this can be distilled into a fairly simple prognosis.
We expect a general trend of falling demand for and prices of lower-risk rated bonds as investors move money into assets such as company stocks which would be more likely to benefit from the economic recovery. We anticipate that this trend will be punctuated from time to time as interest rate or economic growth concerns affect investor confidence.
Outlook for shares
By the same token, we expect share prices in the UK to gradually increase overall. They have lagged their European and North American counterparts not least because of the uncertainties over Brexit. But now, we see some opportunities for previously unloved companies to recover and perform well in a world in which they might be facing less competition.
As profit levels are restored, share dividends can be resumed, which would further increase share prices.
However, the larger companies with more substantial profits will inevitably take a hit when Mr. Sunak imposes increased corporation tax in a few years’ time.
Investors’ tax and allowances
Finally, we feel that the immediate outlook for investors is largely positive. Allowances on capital gains tax, inheritance tax, annual ISA contributions and annual pension allowances have all been frozen. This is good news in the short-term considering some of the worries that wealth taxes might have been imposed, or investment taxes increased.
But there is a sting in the tail. These allowances are set to be frozen for the next few years.
And, as we’ve seen, inflation seems set to rise during this period. As a result, the value of these allowances will be reduced in real terms over time, eating into the true value of capital that investors’ add to their investment portfolios.
The chancellor has to recoup the spending from somewhere, and this is one of the ways in which he’s doing it, while also being sensitive to anything that might prove too unpopular among the majority of voters.
Focusing purely on the perspective of the investor, this budget could have been a lot worse. We applaud the continued support of the economy, and hope that the OBR’s numbers are correct. Even if they are overly optimistic, we think investors will still able to make good use of their tax-free investment opportunities in an environment of economic growth.
Any views expressed are our in-house views as at the time of publishing.
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