The budget, this time around, doesn’t appear to be market-moving, with limited surprises versus market expectations. Our view on UK equities, at this stage, is neutral. The change in borrowing requirements is unlikely to have a significant impact on gilts. And in foreign exchange, we’re neutral on sterling, too. While the weaker growth rate of the UK vs the US does support a strong dollar for now, we could see some modest appreciation when that growth differential diminishes.
The budget | Not a shot in the arm: UK Chancellor Jeremy Hunt announced several fiscal measures, which is mildly supportive of domestic demand. However, the difference these will make to the economy appears rather small given the relatively limited fiscal headroom. It’s also worth remembering that, given the upcoming UK election, these announcements may not be valid for long. The confirmation of the reduction to employee national insurance contributions by two percentage points was basically pre-announced. The Chancellor confirmed that the non-dom tax status will be “abolished” and that the government will reduce the higher rate of property capital gains tax from 28% to 24%. Hunt also announced a new “British Isa”, giving investors a £5,000 extra tax-free allowance to “encourage more people to invest in UK assets”. This seems to be the only policy measure that has had some effect on the domestically-focused FTSE 250 equity index and the shares of some brokers.
The economy | Fiscal plan unlikely to change weak growth trajectory: While the US economy continues to show resilience more or less across the board, the rest of the world, including the UK, remains weak, though no longer getting weaker. The job on inflation is not yet entirely done, but the tide is turning, and we think UK inflation looks set to slow further. That said, the Bank of England doesn’t appear in a rush to cut interest rates as inflation isn’t yet at target. In our baseline scenario, the UK central bank should start reducing interest rates gradually by mid-year. We expect the Bank rate to be about one percentage point lower by the end of the year. Though the growth outlook looks somewhat better and, taken on its own, suggests no imminent cuts, policymakers have room to lower rates as inflation moderates. Loosening monetary conditions will likely alleviate financing risks, a tailwind to the economy and markets that should start to exert positive effects from the second half of this year.
Our tactical positioning | Staying balanced: Relative to our long-term asset allocation, we remain neutral for equities vs bonds. Last month, we added global small cap equities as prices reflect a much more negative growth backdrop vs our base case. These replaced US bonds. In February, we also increased exposure to European investment grade bonds as valuations look compelling. Given the greater yield available from this high-quality bond market, we decided to reduce our exposure to gilts. We closed our low-volatility US equity position in February due to a more positive outlook for the US economy, reinvesting the proceeds into the broad US equity market. We do not think the risk of a recession has completely evaporated, especially in Europe. We keep a slightly reduced exposure to Europe ex UK and still hold low-volatility equities in Europe to protect against a slowdown. Also, we continue to own a reduced exposure to riskier high-yield bonds.
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Information correct as at 6 March 2024
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