Even though the budget, taken at face value, looks somewhat stimulative relative to our baseline, it doesn’t appear to be a game-changer. UK economic growth remains weak, with a recessionary impulse coming through. In this context, we stand by our high-conviction call that interest rates have peaked and, therefore, gilts are attractively valued (with bond prices likely to rise and, therefore, yields to fall). Our tactical positioning is moderately defensive, with more high-quality bonds and less riskier bonds and equities vs our long-term asset allocation.
The budget | Some fiscal easing: UK Chancellor Jeremy Hunt announced that he’ll cut national insurance by two percentage points to 10%, possibly somewhat more than expected. Contrary to previous headlines, there were no changes to the inheritance tax. He’ll also make business investment tax relief permanent, allowing firms to deduct spending on IT equipment, plant or machinery from taxable profits. Whether this increases investment in the economy by some £20 billion per year within a decade remains to be seen. The Chancellor also confirmed that the state pension will rise by 8.5% next April and that other benefits linked to inflation will increase by 6.7% (September’s level, rather than the lower one from October). How much support this provides to the economy is unclear, though the fiscal multipliers (which estimate the spending impact) tend to be low. How much of this plan will stay after next year’s election is an open question, too.
The economy | A flatlined trajectory: With markets still apprehensive about a possible resurgence of inflation versus the UK economy’s weak cyclical outlook, this budget announcement was always likely to be a trade-off between a reasonable fiscal path and some economic support. Taken at face value, some of the measures, if enacted, mitigate the probability of recession (certainty of a deep one). That probability, however, remains fairly elevated, given the lagged impact of rate hikes feeding through, even though we’re talking about a relatively mild recession and perhaps a rather short-lived one. From a market point of view, there’s not much difference between a short, mild recession and a stagnating economy. The key point is that UK economic growth prospects, in the near term, appear rather shallow, though perhaps a bit less than before this announcement and the latest batch of economic data, which generally surprised our expectations somewhat to the upside.
Market implications | Quality bonds a high-conviction call: We think the budget measures and the UK economic outlook still support our call that gilts are attractively valued. As economic growth and inflation slow, we think bond yields will fall, and bond prices will increase, making it an opportune moment to lock in a decent yield for a reasonably low risk. Conversely, in our view, the additional yield of lower-quality bonds seems too small to take the extra risk, especially as markets haven’t fully dealt with the impact of past interest rate hikes, and so default rates may pick up more than expected. Our tactical view on UK equities, at this stage, is neutral. We’re neutral on sterling, too. The weaker growth rate of the UK vs the US supports a strong dollar for now. But we think the trajectory for sterling is more sideways going forward, with perhaps some modest appreciation when that growth differential (with the US slowing, too) diminishes.
Our tactical positioning | Moderately defensive: We think the Bank of England is unlikely to raise interest rates further unless there is a spike in inflation. It’s more likely to keep them at the current restrictive level before reducing them gradually from the mid to second half of 2024. We think high-quality bonds are attractive as interest rates have peaked, growth slows, and inflation eases. Therefore, we hold more government bonds and fewer riskier bonds relative to our long-term allocation. We remain invested in low-volatility equities in the US and Europe (which tend to give a proportionally higher weight to the UK). We’re also positioned with a lesser weight to US equities (slightly) and Eurozone equities (somewhat more markedly). Our single-line portfolio holdings remain biased towards investments that we believe demonstrate solid long-term growth prospects and strong balance sheets. These attributes can serve as a buffer in the event of market volatility.
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Information correct as of 22 November 2023.
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