A Budget of Trade-offs for the UK

Here are some quick takeaways from the UK budget released today.

Here are some quick takeaways from the UK budget released today. This was the first budget by a Tory-only government in almost 20 years, but in our view, it was less “conservative” than could have been expected. Specifically, here are the three main points:

First, it was a budget of many trade-offs. For example: Increasing the minimum wage while at the same time lowering corporate taxes; reducing the levy on banks but creating a profit surcharge; lowering benefits for low income earners while lowering the taxes they will pay.

Second, “Devolving” was one of the buzzwords. This is probably in response to the change in political backdrop as a result of the decisive victory of the Scottish National Party. For example, local authorities will be given the say on retail opening times. It also awarded more powers to Greater Manchester and is working on similar deals with Sheffield and Liverpool, in line with the “Northern Powerhouse” meme. (i.e. an attempt to address the North-South imbalance by helping cities and towns in the North attract investment.

Third, many of the measures announced come right from the Labour party platform, or sounded very much like something they would propose. These include increasing the minimum wage from £6.50 now to £7.20 next year, and to £9 by 2020. A change in tax regime to the buy-to-let market was announced, aiming to address soaring rent prices. Osborn resisted calls to reduce the top income tax rate for those earning over £150K from the current 45%. Several new tax avoidance rules were announced, including tax reforms to those on a non-domicile status, which was part of Miliband’s electoral campaign in the last elections. Some have also seen the push towards devolution to the North as encroaching into Labour territory. Overall, welfare cuts were lighter handed than many had expected. As the BBC economics editor put it, “the path to austerity is much less painful that we thought.”

Some additional points:

  • Growth forecast was revised slightly lower for 2015 to 2.4%, and remains unchanged at 2.3% for 2016.
  • The budget deficit is expected to fall to -3.7% of GDP, then to -2.2% in 2016-17, and near zero in 2018-19.
  • Debt to GDP ratio is seen at 80.3% this year, then falling to 79.1% next year, and targeting 68.5% in 2020/21.
  • The public sector got only a 1% pay increase for the next four years. This could spell trouble, since the public sector has seen its pay restricted for the last 5 years.
  • Increasing the inheritance tax exemption to £1 mln.

The market reaction was mild. The back end of the gilt curve saw yields rise a few basis points, perhaps in response to a slower pace of austerity. But in the short end, expectations for the timing of the first BOE hike were little changed. Implied rates are still suggesting the move will come between July and August of 2016, with the skew leaning more towards the latter. The pound is underperforming on the day, but it was already weaker prior to the announcement. The same goes with the outperformance of the FTSE index.