Navigating the Shifting Tides of Fiscal Policy and Economic Projections

Last week brought forth a blend of fiscal surprises and economic forecasts that set the tone for the market. Global equities witnessed a mixed performance, gaining 0.8% in local currency terms but experiencing a 0.5% loss in sterling terms due to the pound’s notable strengthening against the dollar, reaching $1.26.

In the UK, government bond yields made an upward turn, counteracting recent declines. This shift was predominantly led by the Autumn Statement, setting the stage for Jeremy Hunt’s intriguing revelations that captured investors’ attention.

The Chancellor opted for a strategic move diverging from the widely anticipated income tax cuts. Instead, he announced a substantial reduction in National Insurance rates, notably slashing the main NI rate from 12% to 10%. These measures, estimated to cost around £10 billion annually by 2027/28, provided a pleasing surprise to many. Additionally, the Chancellor solidified the current business tax rules, allowing full expensing of investment against tax. This move, presented as the largest business tax cut ever, also carries an eventual cost of around £10 billion.

However, while these tax cuts may resonate positively, two crucial factors slightly dampened the enthusiasm. Despite the reductions, the tax burden is projected to rise to a record 37.4% of GDP due to stealth tax increases resulting from frozen income tax thresholds amidst soaring inflation. Moreover, the lack of increased government spending aligned with inflation now forecasts a real-term decline in departmental spending in the upcoming years, posing a challenge for future administrations.

Despite these fiscal manoeuvres, the immediate impact on growth seems modest. Around 110 growth-boosting measures were introduced to stimulate the economy, yet their short-term influence appears limited. Furthermore, these tax cuts might slow down the Bank of England’s rate cuts, altering market expectations. The anticipation of rate decreases, previously set for earlier, has now been slightly pushed back, with expectations suggesting a start next summer and a 0.5% decrease by year-end.

Concurrently, the UK economic releases offered a glimmer of optimism. Business confidence, after a prolonged recessionary period since summer, showed slight improvement in November, signaling a shift away from a recessionary outlook. Consumer sentiment also displayed a marginal uplift this month.

This blend of factors sets the UK economy on a trajectory for a modest growth of approximately 0.5% next year, mirroring this year’s performance. Although not a reason for exuberance, this projection marks a stark contrast from the previously anticipated recession, boosting gilt yields and bolstering the pound last week.

In the realm of UK equities, the Autumn Statement had marginal effects, with large, mid, and small-cap stocks ending the week with slight declines. Yet, the UK market holds promise, given the attractively low valuations across various sectors. With recession avoidance on the horizon and potential rate cuts in view, small and mid-cap stocks, geared more toward the domestic market, seem to offer compelling opportunities.

This week’s fiscal revelations and economic insights have unveiled a mix of challenges and possibilities, shaping a landscape where cautious optimism prevails, setting the stage for nuanced investment strategies.

Sources: Reuters, Bloomberg, CNBC and Financial Times

 FAQs

1. How did global equities perform last week?

Global equities exhibited a mixed performance, gaining 0.8% in local currency terms while experiencing a 0.5% loss in sterling terms due to the strengthening of the pound against the dollar.

2. What led to the upward movement of government bond yields?

The increase in government bond yields, particularly in the UK, was driven by the Autumn Statement, which included unexpected tax cuts and changes in National Insurance rates.

3. What were the significant announcements made in the Chancellor’s statement?

The Chancellor introduced substantial reductions in National Insurance rates, dropping the main NI rate from 12% to 10%. Additionally, he announced a permanent rule allowing businesses to fully expense investments against taxes.

4. What impact did these tax cuts have on the fiscal outlook?

While these tax cuts aimed to reduce the tax burden, forecasts still predict an increase in the tax burden to 37.4% of GDP due to frozen income tax thresholds amidst high inflation, raising concerns about future government spending.

5. How did the market react to these fiscal measures and economic forecasts?

Despite the tax cuts, which slightly alleviate growth restraints, their immediate impact appears modest. The market also adjusted its expectations on the Bank of England’s rate cuts, projecting a slower initiation than previously anticipated.

6. What were the recent economic indicators in the UK?

Recent economic indicators portrayed a slight improvement in business confidence and consumer sentiment in November, hinting at a departure from recessionary concerns.

7. What are the projections for the UK economy next year?

Forecasts suggest a modest growth of around 0.5% for the UK economy in the upcoming year, signalling a more positive trajectory compared to previous recessionary forecasts.

8. How did the UK equities respond to the Autumn Statement?

UK equities, comprising large, mid, and small-cap stocks, saw marginal declines following the Autumn Statement. However, the market still presents opportunities, especially with attractively low valuations.

9. What are the potential opportunities in the UK market amidst these developments?

Amidst recession avoidance and prospective rate cuts, small and mid-cap stocks, emphasising the domestic market, appear promising for investment opportunities.

10. What is the general sentiment regarding the fiscal and economic shifts in the market?

The market outlook combines cautious optimism, acknowledging the mix of challenges and opportunities stemming from fiscal policy changes and economic projections.

If you have specific questions or concerns about your investments, don’t hesitate to reach out to our financial advisers for personalised guidance and recommendations.