Sterling has been relatively stable throughout today’s budget, while front-end gilt yields have risen the most in the developed market space today – up 3.9bps on the 2-year. While the moves are minor, they come at a time when the dollar trades stronger against the G10 and front-end yields sit flat.
For markets, although the £65bn in new spending outstrips expectations, which sat at around £20-40bn in new spending, the positive impact the spending pledges has on growth has been somewhat offset by concerns of fiscal consolidation later down the line.
While we didn’t expect Chancellor Sunak to drop the fiscal anchor at today’s budget given the fluid nature of the economic recovery at present, the rise in the projected deficit from £164bn to £234bn has stoked the bond market’s concerns over the financing of this debt at a time when yields are rising.
This comes in spite of the projected deficit in GDP terms shrinking over the next four-years relative to November’s forecasts. Today’s budget hinted at the consolidation efforts expected in the near-future, likely in the Autumn budget, with the highly talked about corporation tax increase in April 2023 to 25% being announced – this is earlier and larger than most expected. Although, companies with profits under £50,000 will continue to pay 19%, meaning only 10% of companies will pay the higher rate.
POST BUDGET: DIGESTING THE OBR REPORT
The March budget continues to dominate the focus of UK financial markets, with sterling continuing to trade flat against a stronger dollar and gilt yields remaining elevated on the day. The market will now digest the latest report on the budget from the Office for Budget Responsibility after the Debt Management Office stated gilt issuance will be £295.9bn – again outstripping expectations by around £50bn. While some of the headline figures from the OBR report were listed by the Chancellor during the statement, such as improved growth forecasts and deficit projections, investors now get the opportunity to pick through the report as fixed income markets continue to price in the higher than expected issuance.
The budget was more stimulative than expected. This isn’t just outlined by the overall cost of £65bn (3.1% of 2020 GDP), but the breakdown of the spending in the OBR report.
Firstly, the extension of the virus-related support measures to households, businesses and public services outstripped expectations by coming in at £44.3bn. Many had put this number at around the £20bn mark heading into today’s announcement, with the overall figure largely inflated due to an increase in the CJRS beyond June until end-September, an expansion in eligibility for self-employment support schemes, and new business support grants (£5bn). On top of this, extensions to the business tax holiday until June (£6bn) and an extension in the VAT reduction for the hospitality sector until September (£5bn) – with it rising to 12.5% until returning to 20% in April 2022 – along with other measures sees the overall tax break costing more than £12bn a year. This is to aid the recovery and for businesses to temporarily bring forward investment.
On this front, the spending package looks even larger, however, some measures were taken to consolidate the increasing debt pile early on.
Corporation tax for companies with profits over £50,000 was increased from 19% to 25%, effective April 2023, which should bring in about £16-17bn a year. Meanwhile, personal income tax brackets were frozen, adding another roughly £1bn a year in revenue. Additionally, departmental spending plans were cut by around £4bn a year. This should raise a total of £31.8bn by 2025-26 according to the OBR. On the other front, improved growth forecasts continue to do some of the heavy lifting – the OBR now expects the UK economy to return to pre-Covid levels by mid-2022 instead of end-2022 previously. This is visible in the upwards revision to the 2020 forecast, along with the expected faster growth in 2022 once the UK economy is opened on a more structural footing. Taken together, the faster growth baseline and the signs of initial consolidation efforts see a downwards revision to the government’s deficit forecasts. They now sit at 4.5% for this year (vs 4.4% in November), 3.5% in 2022 (vs 4.1%), and 2.9% and 2.8% in 2023/24 (vs 3.9%, 3.9%). This will help soothe concerns about fiscal consolidation efforts being more dramatic further down the line. But any slip in the growth outlook between now and the Autumn budget will undoubtedly see the prospect of additional tax increases come back into focus.
OBR GDP forecasts – March 2021 vs November 2020
Gilt curve rises across the board as Sunak’s budget sounds expensive to markets
GBPUSD and GBPEUR unmoved by bumper budget
Our Senior FX Market Analyst Simon Harvey spoke with Reuters on the market reaction to the budget. You can find the full commentary here
Author: Simon Harvey, Senior FX Market Analyst