Jury out on budget as yields edge higher

The last few weeks has seen a lot of speculation in both economic and political circles as to how the first budget of the new government is likely to hit not only the pay packets of ordinary working people, although that particular demographic has become much harder to define recently, but also the UK economy in general.

Much has been made of a so-called “black hole” in the public finances, whether it be £20bn or £40bn, however the fact remains that the new governments messaging on this has been to damage investor confidence in the UK on a global level, and the hope was that today’s budget would help restore some of that once all the detail became known.

Now that the day has come, we know that taxes will rise by £40bn, while the Chancellor also confirmed a change in how government debt is calculated using (PSNFL) or Public Sector Net Financial Liabilities, which includes student loans, to help allow the new government to borrow more to fund any new “investment programs”.

There has been a modest market reaction to today’s announcements, largely due to the fact that some of the worst-case scenarios have been avoided, however some of the tax increases announced are still fairly significant, pushing the total tax take to a potentially historic high of 38% of GDP by the end of the decade.

On businesses the Chancellor announced that she was looking to raise £25bn by increasing the rate of National insurance contributions to 15% from 13.8%, from next year, as well as reducing the secondary threshold at which employers start paying NI on each employee’s salary to £5k from £9.1k, although some small businesses will be exempt.

At the same time, it was announced that there would be a new single adult rate for the minimum wage, phased in gradually, which would be set at £12.21p per hour, a rise of 6.7%, while raising the 18–20-year-old rate by 16.3% to £10 per hour.

This target of £25bn seems somewhat ambitious given that these higher costs could well prompt some employers to think twice about hiring more staff due to impacts on margins, or even worse could well force them to downsize in order to preserve profitability.

We also saw increases to capital gains tax, from 10% to 18% on the lower rate and from 20% to 24% on the higher rate, while inheritance tax thresholds were left unchanged until 2030, there were some tweaks to inherited pensions as well as possible changes to agricultural and business property relief.

Tobacco duty would also increase by RPI +2% for the rest of the parliament, while duty will also be added to vaping products from October 2026.

Stamp Duty on second homes will also increase to 5% from tomorrow.

The government also confirmed the increase to the windfall tax on oil companies to 38% from 35%, as well as extending the levy by a further year, taking the total tax paid by oil companies with assets in UK territory to an eye-watering 78%, from 1^st November.

The Chancellor also said that the levy’s 29% investment allowance would be scrapped. This levy allowed companies to offset the tax from capital that is reinvested, and could well further hasten the demise of investment in the North Sea.

On the plus side, fuel duty was left unchanged with the Chancellor perhaps aware that to further add to cost-of-living pressures in such an overt way would be a step too far.

The Chancellor was at pains to say that today’s budget was a “Budget for Growth” with a number of new investment programs announced, including pouring another £22.6bn into the NHS, as well as £6.7bn into education.

Another £100bn would be spent on various capex projects, including extending HS2 to Euston, as well as funding for 11 green hydrogen projects totalling 125MW of capacity around the country.

Against this sort of expansionary fiscal policy, it is therefore noteworthy that the OBR downgraded its growth forecast for the UK economy to 1% for this year, rising to 2% in 2025.

Having got off to such a strong start to the year in the first half, this downgrade is disappointing given that UK economy posted 0.5% GDP growth in Q2, a modest slowdown from the 0.7% in Q1, with the services sector growing by 0.6%, accounting for all of the expansion.

Unemployment has also been on a downward path from the peaks we saw earlier this year when it edged up to 4.4%, and has since fallen back to 4% in the 3-months to August.

Inflation has also been coming down gradually, slowing to 1.7% in September, and below the BOE’s 2% target rate for the first time since April 2021, although this does need to be put in the context of sharp falls in petrol prices, which while good for overall spending power, tend to be extremely volatile.

If you look elsewhere, there are warning signs with services and core inflation proving to be stickier at 4.9% and 3.2% respectively.

This is a little more worrying, as it is here that there is some concern that prices could prove to be much harder to come down, and it is here that we could see recent pay rise inflation manifest itself.

This in turn could prevent significant further future sharp reductions in interest rates from the Bank of England in the coming months, at a time when growth is slowing.

It is no secret that the likes of external MPC members Catherine Mann and Megan Greene have concerns about this area of the economy, and it is here that the new government needs to tread carefully.

With the tax burden approaching multiyear highs, and government spending above the long-term UK average of 40%, we appear to be nearing the limits of how much the private sector of the economy can absorb before the actual tax take starts to slow, and impact the economy’s growth potential.

The government has already been warned that further tax increases without productivity improvements will have little effect, from freezing tax thresholds further, and increasing taxes like capital gains tax could well be tax negative in the coming years.

These pleas appear to have fallen on deaf ears today and while markets appear to have taken today’s budget in its stride, gilt yields have already started to move higher again, suggesting that markets remain concerned about the longer-term impacts of the government’s spending plans.

This material (whether or not it states any opinions) is for general information purposes only and does not take into account the readers personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by the author that any particular investment, security, transaction, or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research.