This article is by Justin Rourke – Head of Advice at Armstrong Watson Financial Planning & Wealth Management and Richard Cole, Fund Manager at Future Money Ltd. We aim to provide you with our commentary on the latest economic and investment developments which are likely to be affecting your investment and pension portfolios.
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In this latest market update we discuss the economic and market implications of the budget.
Rachel Reeves’ budget is a clear change of direction from that of the previous government. While Covid necessitated a surge in government spending, the Conservatives’ instincts of the last 14 years have been for lower taxes, lower spending and a smaller state. Labour’s first budget has, in contrast, been about higher taxes, more borrowing and greater public spending.
With nearly 4 months between their election and the budget, the absence of policy allowed speculation to thrive, but now with the budget having been delivered we have greater clarity on the direction this government will take. While there is a huge amount to digest for individuals and businesses alike, in this piece we will address the most important points for the economy and for investment markets.
Economic growth
The budget is likely to lead to a brief upturn in our economy, with the Office for Budget Responsibility (OBR) forecasting that real GDP growth will beat previous expectations in this year and next. Yet these gains are not forecast to last, with growth forecast to equal previous expectations in 2026, and then to fall to a lower than previously expected growth rate in 2027, ’28 and ‘29.
On the positive side for the economy is the higher public spending that will come from greater investment in areas like the NHS, while the rise in the minimum wage will also help out those with lower incomes, who typically have a higher propensity to spend extra cashflows than those with deeper pockets.
Yet on the downside for growth is the implications of the £25bn to be raised from higher National Insurance (NI). By making labour more expensive for employers, these costs will feed through to lower earnings on average. Companies will likely passthrough the higher NI contributions to staff through lower future pay rises, lower pension contributions or lower jobs creation/more redundancies.
The Chancellor adopted this policy as the largest revenue raiser as a way to balance her books, while being able to argue she hasn’t broken a manifesto promise. Yet, however it is positioned, taxing employment will have an impact and is expected to be detrimental to economic growth over the medium term.
Borrowing Costs
The Chancellor has moved to a new definition of public debt, with public sector net financial liabilities (PSNFL) now the official measure. This allows the counting of assets held in the public purse (such as student loan repayments) to offset debt levels and in doing so creates significant space to increase borrowing levels, while maintaining promises to have debt falling as a proportion of GDP. This had the potential to spook investors, had this have been interpreted as abandoning fiscal prudence in the same way as Liz Truss and Kwasi Kwarteng were perceived to have done. Yet, given that Reeves announced this change in advance of the budget, and explained both her justifications and the guardrails which would keep borrowing in check over the longer term, markets appear sympathetic to this change. As the Chancellor was speaking, bond yields actually fell (reflecting confidence in her plans).
Yet, following the budget, attention turned to the Debt Management Office’s latest release showing that UK debt issuance was to rise by more than previously expected. This, together with further digestion of the budget’s borrowing intentions, led to bond yields rising (bond prices falling) after the budget was announced.
While this is significant, it is also important to keep some perspective. The UK isn’t the only market with rising bond yields, with US treasuries having fallen in value by similar amounts to UK gilts over the past month. This shows the rise in the UK’s borrowing cost isn’t solely down to the budget, with anticipated higher spending in the US following the presidential election a factor which is having global implications.
Interest Rates
While higher levels of public borrowing in both the UK and US are behind some of the increases in government borrowing costs, the slight increase to inflation forecast as a result of the budget is another factor. This is also likely to slow the pace at which the Bank of England lowers the UK’s official interest rate. The OBR forecast that the UK Bank rate will settle at around 3.5% from 2027 onwards, rather than the approximately 3.25% level that would have been expected without the announced budget measures.
Equity market reaction
Bond markets have fallen a reasonable amount in reaction to the budget, but within equity markets there are more mixed reactions.
The FTSE Alternative Investment Market (AIM), which is popular for intergenerational investments given its previously favourable inheritance tax status, rallied by approximately 4% following the budget. While IHT exemptions were reduced, with a 20% tax liability now applicable (rather than the 0% previously in place), this was not as bad as could have, given that the imposition of a 40% tax rate had been increasingly expected from the budget.
More traditional equity markets were less affected by the budget announcements, however. The FTSE 100 was down by a small amount, while the mid-cap focused, FTSE 250, was up slightly immediately following Wednesday’s announcements. On Thursday, equity markets fell by around 1-1.5%, but with similar movements in European and US shares (at the time of writing) this is indicative that equity investors’ attention had already been drawn elsewhere, with US labour market data and earnings results from a number of large US technology companies due to be published.
US election
Attention moving across the Atlantic is likely to continue over the coming days as well, with investors increasingly focusing on the implications of the US presidential election. A Trump victory is expected to mean lower taxes and lower business regulation (boosting factors for equities), yet his threat of tariffs could well be destabilising. This week’s budget is important for the direction of the UK economy, yet the question of who will occupy the White House for the next four years is likely to have the largest impact on market sentiment from next week onwards.
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Important Information
Please note that the contents are based on the author’s opinion and are not intended as investment advice. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested.
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