In this quick-take, Ross Walker and Theo Chapsalis outline four key announcements they expect from the UK Autumn Budget, what they could mean for markets and the economy, and key risks you should consider.
- Higher growth in the near term, but challenges up ahead: higher inflation, higher interest rates, supply chain issues and shortages could all weigh down the longer-term outlook.
- Potential measures to cushion the blow from the energy crisis and the pandemic: a VAT cut on energy and slowing curbs to Universal Credit could be on the cards.
- Significantly lower government borrowing on the back of improving public finances: but realpolitik could intervene as we head towards the 2024 general election.
- A shift towards longer-dated gilt issuance: tightening fiscal and monetary policy raise risks for shorter-dated debt but makes for a bullish outlook on longer-dated gilts.
Higher economic growth sooner, lower growth later
The UK economy grew much faster in 2021 than many were anticipating earlier this year, so we expect the Office for Budget Responsibility (OBR) to revise its full year growth forecast upward by a considerable margin (2.5%). But we also see this being offset in 2022, partly as a result of the huge spike in inflation this year.
Beyond next year, we think the combined effects of higher inflation, higher interest rates, supply and labour shortages, and supply chain disruption – caused partly by the pandemic, and partly by Brexit – will weigh on businesses across the economy and translate into lower growth when compared with March 2021 estimates (see chart below).
Economic growth (Gross Domestic Product) will be higher in the short-term, lower in the medium term
Make sure you check back for our UK Autumn Budget Review after October 27.
Some measures to cushion the blow from the energy crisis and the pandemic
We expect the Autumn Budget to be broadly neutral but likely to include some measures to cushion the blow from the rapid rise in energy prices and the residual effects of the pandemic. This could include a temporary VAT cut on energy – which at 5% is, pardon the pun, a drop in the barrel in fiscal terms, but could help lower-income households. We also think they would benefit from a potential decision to slow cuts to Universal Credit if it comes to pass.
Despite remaining broadly accommodative, the Chancellor has signalled a desire to get UK public finances on a more stable, sustainable footing. The recent announcement of £12 billion of extra spending on health and social care in 2022 and 2023 will be fully funded by National Insurance tax rises from April 2022 despite considerable headroom to borrow (more on this below), sending a clear signal – and echoing his pledge earlier this month at the Conservative Party conference to “fix our public finances”.
But at the same time, we suspect financial markets will take the view that government spending will become increasingly influenced by the election cycle. This kind of realpolitik could see the Chancellor exercise restraint this year and next in order to create more room for greater spending ahead of the next general election in 2024.
Significantly lower government borrowing as tax haul rises and spending eases
UK public finances have fared better than feared, which is the main reason why we see the government undershooting its borrowing targets into next year.
Cumulative public sector net borrowing (£ billions) is well below estimates
There are two main drivers behind the borrowing undershoot: a larger-than-expected tax haul across the board and lower-than-expected public spending. The Treasury’s take from income tax, national insurance contributions, corporation tax and VAT, cumulatively, is up 42.1% in the first five months of this fiscal year compared with the same period a year ago. Pandemic-related support measures, most notably the furlough scheme, are also being wound down.
There are, of course, still sizeable deficits in the near-term, even if slightly less bloated than what was forecast earlier this year. In 2021-22 we think the shortfall will touch £190 billion, equal to 7.9% of GDP; although down from £234 billion, that’s still the highest level seen since the Global Financial Crisis. The outlook Yet the clear trend for public finances this year is one that sees the pandemic exert less and less influence, which also extends to how we think the government will raise debt.
A shift towards longer-term gilt issuance
Though we expect lower gilt issuance overall (we estimate by some £42 billion) we think the UK debt management office (DMO) will reduce short-dated gilt sales and lean more heavily on longer-term debt. A key message conveyed by the OBR in its July 2021 Fiscal Risks report is its desire to increase the weighted average maturity of its debt stock. At the same time, greater certainty over public finances and a less influential pandemic will reduce the government’s reliance on shorter-dated borrowing (see below). We also think that having the support of quantitative easing helps make the case for longer-term gilts.
Composition of gilts will favour long-dated and inflation-linked gilts (% proportion of gilt supply)
For markets, the outlook for gilts – particularly longer-dated debt – seems much more bullish than was the case six month ago. We think the UK government and the Bank of England tightening up spending and monetary policy, respectively, could have important growth and inflation implications that only raises the chances shorter-dated debt will experience more price volatility, to the benefit of the long end of the yield curve. Long-dated Inflation-linked gilts should also benefit in an environment where the transitory nature of price rises is increasingly called into question.