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The first Budget for the new UK Government marks a shift in political focus from minimising taxation at the expense of public services to prioritising the latter. This change comes at a time when the costs of the pandemic still need to be addressed. The fundamental economic problem in the UK has always been that voters demand European-style public services, particularly in health care, while also expecting US-style low taxation. It is a balancing act where political expediency often outweighs economic reality. A Labour government will inevitably mean that the pendulum swings toward greater costs for both UK consumers and businesses, especially given the tax gap between the UK and our major European competitors, who will also be forced to increase their tax take in the coming months. The problem for UK markets is that, while the tax take has increased, funding for enhanced public services will largely be borrowed from the markets. In an ideal economic scenario, day-to-day government running costs—such as those for health, education, and defence should be covered by taxation, with borrowing reserved for strategic investments that generate economic growth or enhance efficiency. The Treasury’s independent watchdog, the Office for Budget Responsibility, has actually downgraded its forecasts for economic growth following the Budget and expectations for UK mortgage rates have risen, not a good outcome. We are facing higher taxation, increased borrowing, higher interest rates, and less growth. Understandably, Gilts have fallen in value. The Labour Manifesto focused on funding enhanced public services through higher growth, but this is not the case after this Budget. Does Rachel Reeves have an additional growth plan that has yet to be revealed?

UK Budget

To deliver on her manifesto plan to “rebuild Britain,” Reeves raised taxes by approximately £40 billion a year, the most since Conservative Chancellor Norman Lamont’s 1993 budget after Britain was ejected from the European Exchange Rate Mechanism. This tax hike was intended to cover the bulk of a £70 billion annual increase in public spending, along with a further £142 billion of borrowing over the course of the five-year Parliament (front-loaded). This represents a fundamental economic and political shift back to “big state economics.” The head of the OBR stated that the plan amounts to “one of the largest increases in spending, tax, and borrowing of any fiscal event in history.” According to the OBR, spending as a share of gross domestic product will be 5% higher than before the pandemic and 2% higher than the last March forecast under the Conservative government..

UK Budget…..Investment

Reeves pledged to turn the nation’s fortunes around through a substantial investment program. She has committed to an additional £100 billion for capital project investment over the next five years. Reeves is on track to be the highest-investing Chancellor since the 1970s, with net investment projected to average 2.6% of GDP in the current Parliament, up from the 2% forecasted (but not spent) by Sunak and Hunt. However, according to the OBR, crucially, the returns from this investment will not be realised until at least five years later, i.e., after the next election. This is, nonetheless, the government’s “seed capital,” and the plan has always been to encourage City institutions, such as pension funds, to provide the bulk of the investment capital. This aspect was beyond the scope of the Budget and we may have to wait for the Mansion House Speech to see the regulatory changes necessary to implement this. Again, this is not included in the OBR’s forecasts, so there may be some good news to come. However, economists have pointed out that personal consumption will be impacted by an estimated £18 billion reduction in wages, as businesses are likely to pass on the majority of the £24 billion tax increase. Weaker consumer spending could more than offset the initial 0.14% investment boost to GDP.

UK Budget…..Staff Costs and Wages

The government ideally would have sought to reverse the Sunak/Hunt cut in personal National Insurance Payments, however, to uphold the manifesto promise of protecting “working people’s pay packets,” instead, we saw a significant hike in employer National Insurance Contributions. Not only did the rate of employer NICs increase to 15% from 13.8%, but the earnings threshold at which it kicks in also dropped to £5,000 from £9,100. As a result, a worker being paid £9,100 a year will now cost an additional £615 a year to employ. For businesses that employ many part-time, low-paid workers, their National Insurance bill is about to skyrocket, and this is before factoring in the increase in the Minimum Wage. The OBR estimates that about three-quarters of this rise will ultimately be passed on to staff in the form of lower “real” wages. Moreover, this change only affects the private sector; the public sector will be insulated from it. The hospitality and care industries, already struggling to recover from the impact of COVID-19 and higher food and energy costs, may have just received a near-mortal blow.

UK Budget……Tax Burden….. is it enough?

Despite the tax burden being high, the UK, even after this Budget, will rank low on the G7 league table. Indeed, for many countries, this table does not include healthcare costs. Given that Reeves’ spending plans disappointed ministers in departments outside the protected areas of health, education, and defence, there will be pressure for additional funding. For example, the Home Office will face real-terms cuts in spending over the next two years, and other departments are anticipating cuts from 2026 onwards, again according to the OBR. The Resolution Foundation think tank stated that “pockets of austerity” are likely over the five years of the Parliament. In particular, local government spending remains under intense pressure, which brings upward risk to council tax rates. Overall, this could signal the start of a tax-raising process rather than a “one-and-done Budget.” Much will depend on growth.

UK Budget….Where is the growth going to come from?

1. Global economic recovery, driven by lower US, European and UK interest rates. This should stimulate the UK housing market. Which in turn should be helped by the promised, though not as yet delivered, planning reforms. Housing market growth remains the major driver of wealth creation in the UK. The US economic recovery could yet help Reeves out.
2. Institutional reform. Plans to change the regulation of UK Pension Funds to allow greater infrastructure, housing and Private Equity investment also remain promised and as yet undelivered. Furthermore, there are plans to merge all Local Authority and other government funded pension investments into a single national investment fund. A sensible move, though again promised and undelivered. In theory this should provide the “wall of capital” for investment in the UK.
3. Europe, this remains the “wild card”. Both sides need one another for an economic boost, but this remains a toxic subject in the UK. Nevertheless, the extended trade deal including Banking and Financial Services is yet to be agreed and signed, thus, a move into a “Norway-style” customs zone arrangement is quite possible.

UK Market reaction

The markets were initially nonplussed by the Budget until the scale of Gilt issuance became apparent: £390 billion front-loaded over the next couple of years. Furthermore, this fundraising would occur at the volatile long end of the yield curve, primarily involving 15 to 20-year bonds being issued. The crucial 5-year Gilt yield, which affects mortgage rates, moved up to 4.4%, having been below 4.0% just a few weeks ago. Consequently, mortgage rates have increased and housebuilding shares declined. The overall reaction was though one of repricing rather than panic selling. The US Presidential election will dominate the markets, and the UK Budget will soon be forgotten. However, it’s fair to say that this was a particularly business-unfriendly Budget, in marked contrast to the pre-election briefings given by Starmer and Reeves. It is clear to us that, while painful, this is not enough. The long term sums simply don’t add up, she needs to deliver on growth. The global backdrop is favourable, meaning the UK will be swimming with the tide, but institutional reform and maybe even a closer relationship with the EU might be needed soon. UK businesses have taken a hit just as things were starting to look up. For the markets, this is now history, it’s the Presidential Election that counts.

November 2024