7 minute read
With the UK budget set to be revealed in a matter of days, Ross Walker & Theo Chapsalis take a closer look at what to expect, the potential impact on the economic & market outlook and key risks you should consider.
- Fiscal policy will remain accommodative: we expect (slightly) less accommodating policy, rather than tightening.
- Taxes pose a deficit reduction risk: most of the deficit reduction will likely come from a pullback in pandemic related spending – but broadly stable tax projections could pose a risk.
- The economic outlook is broadly unchanged: we anticipate a modest lockdown-driven downward revision to growth in 2021 and a slight uptick in 2022.
- Public sector borrowing may drop slightly: we expect lower borrowing in 2021-22, partially offset by lower growth and additional fiscal stimulus.
- Slightly more quantitative easing slightly later: we think a slowdown in the current pace could be announced as soon as March but expect a small top-up in early 2022.
- The composition of gilt issuance will shift to favour longs, linkers, & greens: we also see a big pullback in short & medium-term debt issuance, favouring higher yields.
Fiscal policy: less accommodating rather than tightening, despite some hawkishness
Since the March 2020 Budget, the UK Government has announced £280 billion of discretionary fiscal spending – in effect the cost of the coronavirus policy response – principally in the form of public services (mainly healthcare), employment support (the furlough scheme) and grants & loans to businesses (see chart below).
The cost of pandemic-related policy measures in 2020-21 FY (£bn)
Sources: Office for Budget Responsibility (OBR), Office for National Statistics (ONS)
We see UK fiscal policy remaining significantly accommodative this year, with modest spending growth to help cushion (what is hopefully) the endgame for coronavirus-related restrictions.
“Our estimates are somewhere in the region of £5 billion or 0.25% of gross domestic product (GDP) in new spending, and possibly double if the Universal Credit uplift is maintained.”
There may be some fiscally ‘hawkish’ medium-term rhetoric from policymakers, but we think this is more about trying to contain medium-term spending demands than implementing near-term tightening measures. To be frank: a climb-down from the unprecedented (peace-time) deficit in the current financial year – £271 billion to date, and heading for a whopping £365 billion or 17.25% of GDP – through historically proportioned deficits over 5 five years (averaging about 5% of GDP per year) means it would be far more accurate to depict the UK fiscal stance as a continuation of highly accommodative policy, albeit less accommodative than today.
Deficit reduction will be driven by scaling back pandemic-related spending, but taxes are a risk
Lower spending (see chart below), a key driver of the OBR’s deficit reduction projection, is primarily a reflection of pandemic-related spending being scaled-back – notably major measures such as the job furlough scheme.
UK tax receipts & spending (% of GDP)
Sources: OBR, ONS
The main risk in the near-term is larger deficits via lower tax receipts and higher expenditure. The risk to tax revenues is partly a reflection of the broadly stable and relatively high projection for tax revenues (about 38% of GDP over a 5-year period); some Brexit-related factors such as lower income tax and stamp duty receipts from the financial sector; and, our assumption that the Conservatives will honour the party’s 2019 Manifesto pledge not to raise the rates of income tax, National Insurance or VAT.
Economic outlook: modest downward revision in 2021, upward revision in 2022
GDP forecasts (see table below) are expected to be revised lower to reflect the lockdown-induced fall in output in Q1 2021: we expect the OBR to forecast growth of around 5.0% in 2021, down from 5.5% on their previous forecast, but base effects are expected to result in an upward revision to full-year 2022 GDP projections (8.0% from 6.0%), with a broadly unrevised forecast beyond.
OBR GDP forecasts: OBR Nov 2020 f/casts vs NWM expectations for OBR f/casts in March 2021 Budget
Sources: OBR, NatWest Markets
But while we anticipate some recovery during the forecast period, the level of nominal GDP is expected to remain below its trajectory in the OBR’s 2020 forecasts (see chart below) and weigh on expected revenue growth.
GDP level, actual & expected (OBR forecast)
Sources: OBR, ONS. EFO refers to the Economic and Fiscal Outlook as per the OBR forecast.
Public sector borrowing will likely be revised down
UK public sector net borrowing (PSNB) during the 2020-21 fiscal year is on course to under-shoot the OBR’s November 2020 forecasts. On a like-for-like basis (excluding loan loss provisions of around £29.4 billion), PSNB is already running almost £40 billion below the OBR’s full-year forecasts, reflecting both lower-than-expected spending and higher-than-expected receipts (notably from self-assessment income tax).
Although our deficit forecast for this year risks being too low – January’s figures may yet be revised to show higher borrowing, and February-March are vulnerable to adverse lockdown effects – we still expect the OBR to lower its PSNB-ex projection (PSNB excluding loan loss provisions) to around £365 billion from £394 billion, and the Central Government Net Cash Requirement (CGNCR, which forms the basis of gilt issuance) to £380 billion from £403 billion.
OBR borrowing & debt forecasts (£bn)
OBR borrowing forecasts: OBR Nov 2020 f/casts vs NWM expectations for OBR f/casts in March 2021 Budget
Sources: OBR, NatWest Markets
We also expect a more modest downward revision for borrowing in 2021-22, partially offset by lower economic growth and additional discretionary fiscal stimulus.
Quantitative easing: a smaller uplift a little later
Against a backdrop of lower expected borrowing and louder rhetoric from the Bank of England (BoE) about slowing the pace of asset purchases, we expect a slowdown in quantitative easing (QE) to be announced as soon as the March BoE Monetary Policy Committee (MPC) meeting, with the current £150 billion programme lasting until the end of 2021.
That said, the risks are skewed towards ongoing QE being required – probably at a slower purchase pace than at present – given the UK government’s still substantial borrowing requirements. Stopping QE could also result in higher yields across the curve, which if left to rise high enough (we think somewhere between 75bp and 100bp on 10-year gilts) may be regarded by the market as unwarranted tightening.
So, we now anticipate an additional £50 billion in QE to be announced at the February 2022 meeting, which should support gilts in the medium term. It may be that the MPC decides to refrain from ongoing QE and takes its chances in terms of the market reaction. But given that much of BoE policymakers’ rhetoric strikes a cautious tone vis-à-vis the economic recovery, risks remain skewed towards further accommodation.
Gilts: size matters, but so does composition – and we see more linkers, fewer shorts/mediums & some greens
We expect to see a reduction in gilt issuance for the next fiscal year (£249 billion) along with a broader reduction in borrowing, but we also think there will be some notable changes to the composition of borrowing (see below): mainly, more inflation-linked debt (linkers) and to a lesser extent long-dated notes, and a sharp reduction in short & medium-term notes.
A recent shift to more auctions and less syndicated supply
Sources: NatWest Markets, UK Debt Management Office (DMO). The size of each bubble relates to the volume of issuance, the X axis relates to the weighted average maturity of each issuance, with distinct colour palettes for each year.
This will undoubtedly affect gilt yields. A key reason yields remained so low during the 2020-21 fiscal year is that issuance was overwhelmingly short-dated in nature. But more issuance of long-dated notes & linkers tends to favour higher yields. In mid-February we adjusted our rates forecast to reflect a more structurally bearish view: 10-year gilts yielding 0.75% and 5-year SONIA at 0.35%.
Finally, we also expect to hear more on the green gilt programme – the UK’s first foray into the sovereign green bond space. We expect this to complement regular gilt and linker issuance with around £10 billion being allocated to the green borrowing programme, and we suspect that the UK Debt Management Office (DMO) will kick-off the process with a 10-year and a 30-year green issuance in due course.