Brexit poses risk to a budget for a brighter future
Chancellor Philip Hammond used the budget to reaffirm that austerity is ending, but that fiscal discipline will remain, writes Edward Park.
In delivering his 2018 budget last month, Chancellor Philip Hammond’s rhetoric was slightly more optimistic than that used in his last budget speech in November 2017. He focused on the fact that the fiscal deficit has fallen to its lowest level this century, with the government having met its target to reduce debt as a percentage of GDP three years ahead of schedule. Indeed, national debt appears to have peaked in 2016-17, at 85.2%, and in nominal terms the deficit is projected to be less than 1.4% in the next fiscal year, before falling to 0.8% by 2023-24. The chancellor was helped by stronger near-term growth (see chart) and government revenue forecasts from the Office for Budget Responsibility’s (OBR), as well as raised projections for personal tax receipts and corporation tax revenues for this financial year. Overall, his message was that the hard work on austerity has already been accomplished and that this year’s budget “paves the way for a brighter future”.
Spending and Taxation
In line with this, Hammond announced greater spending increases than expected. He reaffirmed the government’s commitment to providing an additional £20.5 billion funding for the NHS over the next five years, with a particular focus on tackling mental illness. He also announced a plethora of spending increases in other areas, including defence, schools, social care, road maintenance, and for the productivity investment fund, which will be bolstered to £38 billion by 2023-24 in order to back the “technologies of the future”. In terms of business, he announced measures to provide funding to British exporters, encourage entrepreneurs and support small businesses, including business rates relief for retailers with a rateable value of less than £51,000. In terms of taxation, the Conservative’s commitments to raise the personal tax allowance and higher rate tax threshold (to £12,500 and £50,000, respectively) were brought forward by a year. To support revenues, the chancellor also pledged to crack down further on tax avoidance and evasion, while announcing reforms to encourage tax collection, including “updating the tax collection system for the digital age”. This includes the introduction of a new digital services tax on large profitable companies generating significant UK revenues.
The reality of the government’s fiscal situation is that it will be dominated by economic growth in 2019-20 and this will be highly dependent on the outcome of the Brexit negotiations. The fact that the OBR increased its near-term growth forecasts but left its longer-term projections subdued is telling. Irrespective of the budget announcements, political risk looks set to continue to dominate UK economic and investor sentiment until clarity on Brexit is provided. A transition deal still provides the best avenue for the government to boost the economy and we agree that the economy will benefit from a “deal dividend” if a Brexit deal is reached. Furthermore, we see scope for sterling to appreciate and put downward pressure on inflation, which would support real wage growth and, therefore, consumption. Although our central expectation remains that a last minute deal will be reached, we are unable to hold high conviction in this thesis given the large number of binary political factors involved. In any case, newsflow surrounding Brexit will continue to generate volatility in UK asset prices, including sterling exchange rates, in the coming months. The closer we get to the secession date (29 March 2019) without a deal, the more volatility we expect to see. While UK assets will likely experience a relief rally if a deal is struck, political uncertainty is likely to weigh on domestic economic growth, and potentially UK assets, in the coming years. Asset valuations reflect these facts and we remain underweight the UK, generally preferring international investments.
Edward Park is an investment director at Brooks Macdonald.