On Thursday, Jeremy Hunt delivered his Autumn Statement. Everything went to plan and it brought a faint smile of relief from the boss.
I’m not talking about Rishi Sunak. The real ‘boss’ at the moment is the global bond market on which we rely, as a nation, to finance our current inability to live within our means. The Government (in effect, us) already owes £2.5 trillion and even after the changes announced on Thursday, we are still on course to borrow a further £386 billion over the next 3 years. We are already spending £120 billion a year to cover the interest on that debt, which is more than the annual defence budget.
The market in UK government debt (gilts) hardly moved during or after the delivery of the Chancellor’s statement. The Chancellor broadly stuck to the script demanded by bond markets and had resisted the temptation to pull any unfunded rabbits from his hat.
Contrast this with the reaction of bond markets in the aftermath of the Truss/Kwarteng ‘mini-Budget’, delivered less than eight weeks earlier. On that occasion, the reaction was swift and severe. The yield on UK government debt soared as gilt prices crashed. In a matter of days, the annual cost of long term debt increased from 3.5% to 5%. In essence, global bond markets made it clear that they were not prepared to finance the proposed fiscal largess, unless we paid a heavy price for it. The ‘boss’ had been stirred from its slumber and savagely attached what markets unkindly referred to as the ‘moron premium’ to the cost of UK government debt. That premium seems now to have receded; the ‘boss’ now believes that grown-ups are in charge of the nation’s finances.
Are Bond Markets Bad?
I don’t want to demonise bond markets because they are not bad. Their job is to lend money (money which often belongs to things that we actually have a vested interest in, such as our pension funds) to governments and corporations in exchange for a reasonable rate of interest and the fulfilment of a promise that the money is eventually repaid.
I remember listening to a speech, many years’ ago, by an American bond fund manager. Annoyingly, I can’t remember his name but I do remember something he said to illustrate an important point. “If you owe me $100, that’s your problem. If you owe me $100 billion, that’s my problem.” This simple statement is a useful way to see the world from the perspective of bond fund managers.
What was really bothering bond markets was the trajectory of our national debt, which was forecast to rise steeply as a proportion of national income. Their view was that it was not sustainable, with the result that our promise to repay what we borrowed was weakened. As Mark Carney, a former Governor of the Bank of England, once so eloquently explained, the UK relies on the “kindness of strangers” and those strangers are not obliged to be kind.
Although budgets seldom produce popular outcomes for the electorate, the reality is that Hunt and Sunak collaborated to create a pathway that was carefully calibrated to appease bond markets, whilst minimising the pain inflicted on the electorate. The fiscal tightening announced amounted to £55 billion, which is a number that was in the right ballpark from the perspective of bond investors.
Hunt and Sunak seem to have got away with back-loading much of this tightening (it won’t be fully achieved until 2027-28) on the grounds that to tighten too much too soon would simply exacerbate the recession that we are now enduring, and will most likely continue to endure for at least another 12 months. The timing is also politically helpful as much of the pain to be inflicted will not be felt until after the next general election.
Nevertheless, just when we thought that the UK tax burden had already grown to an unpalatable proportion of GDP, the measures announced on Thursday will act to push that burden still higher. It will rise stealthily in the coming years as much of the additional tax to be raised will be a consequence of the freezing of many tax allowances and bands, the effect of which is often referred to as fiscal drag. Again, this is a politically expedient strategy, tried and tested by many previous Chancellors, because the electorate does not experience a reduction in take-home pay or pensions; the effect of the change is to reduce the rate at which net income rises.
The back-loading of the fiscal tightening will probably result in the Bank of England needing to do a little more of the heavy lifting in the fight against inflation. Interest rates are likely to rise further than might have been the case, although I don’t see them increasing much beyond 5%.
For many clients of PMW, the forthcoming reduction in the annual capital gains tax (CGT) exemption from £12,300 to £6,000 next year and £3,000 in the following year, will have come as an unwelcome surprise. However, the impact for many will be much less than if the rates of CGT had been equalised with rates of income tax; so it could have been much worse for investors.
The further reduction in the tax-free dividend allowance (from £2,000 to £1,000 and thereafter £500) seems to be more symbolic than fiscally meaningful and as a consequence, is somewhat irritating because it will create an obligation for more investors to submit a self-assessment return to HMRC. In many cases, the cost of professional help with the return is likely to exceed the additional tax payable; not a particularly efficient use of resources. The Government should remember its commitment to reduce red tape.
If there was one goal of the ill-fated Truss/Kwarteng budget that is worth clinging onto, it is the goal of finding a solution to the UK’s poor record of productivity gains and economic growth. Our economy remains smaller than it was prior to the Pandemic. Without higher growth, there is no prospect of maintaining the welfare state and national health service as we know them, because both will need a lot more money as the UK population continues to age. That money won’t be delivered by further increases in the rates of taxation alone. Government therefore needs to create an environment where the economy can grow at a higher rate, which means regulatory reform and better targeted investment incentives for business.
No More Cake
Hopefully, we have seen, at least for the time being, the end of ‘cakeism’ in politics. Everyone can’t have everything they want because that isn’t the way life works and it is disingenuous of politicians to pretend otherwise. The problem is that those that want to eat the most cake are often those not inclined to contribute to the ingredients or even help with the baking.
As the Chancellor said in his Statement, “we need to face into the storm.” Having steadied the ship, the next job for this (in effect) fledgling administration is to plot a more certain course to the calmer waters that hopefully lie over the horizon.