UK Spring Budget Preview

Spring Budget Preview

On Wednesday 6^th March, the UK Chancellor will deliver his Spring Budget. This may be his last budget, as it is likely to be the last fiscal event before the general election, which is due at some point this year. The economic backdrop to this report is mixed. On the one hand the UK economy is in a technical recession, and the Bank of England is predicting only weak growth from here. However, on the other hand tax receipts in January reached a record and so there could be more ‘fiscal headroom’ in this budget to allow the chancellor to deliver more pre-election giveaways.

Will the Tories reduce the tax burden?

The Conservatives are meant to be the party of low taxes, yet the backdrop to this budget is higher taxes that have already been announced. Under the current Conservative fiscal regime public sector receipts are expected to rise from 40.3% of GDP this fiscal year to 41.6% of GDP by 2028/29, which is a rise of some £35bn. Tax rises that are in the pipeline include: a rise in corporation tax to 25%, freezing the income tax personal allowance and the higher rate threshold, vehicle excise duties for electric cars and reversing the increase in stamp duty thresholds. The focus for this budget will be whether or not the Chancellor can offer some relief to households who are expected to see average real income per household fall by 3.5% in 2024/25 compared to pre-pandemic levels. Whether or not he can do this may depend on the UK’s fiscal headroom.

Fiscal headroom: how much does Hunt have to play with?

You will hear a lot about fiscal headroom next week. The government’s self-imposed fiscal rule is that public debt needs to be falling in the 4^th and 5^th year of fiscal forecasts. The difference between the forecast level of debt in the 5th year, and the level that would breach the government's fiscal rules, is known as ‘fiscal headroom’. Some analysts predict that the amount of fiscal headroom for this Budget could be between £15bn and £23bn. Cutting public sector spending could also boost fiscal headroom, however, it is worth noting that the latest opinion polls show that the public want the government to prioritize public spending over tax cuts. The UK has also been warned by the IMF not to cut taxes, lest the country’s debt burden grow unbearable. However, in the run up to the election, and with pressure from Conservative party insiders, it will be hard for the chancellor to avoid a show piece tax cut, even at the expense of ignoring the IMF.

Potential tax changes

The headline grabbing tax cut could come from a further cut to national insurance or a cut to income tax. The latter would be incredibly expensive, while the former might be cheaper, but may not be as popular as an income tax cut. Interestingly, there have been fewer pre-budget leaks to the press about what this budget could hold, so any surprises could trigger a large market reaction, particularly for bonds, FTSE 250 stocks and the pound.

Other tax cuts that the government could target include:

• Cuts to inheritance tax
• Changes to savings allowances for ISAs etc., and more detail on how and what you can invest in when using an ISA
• Reinstating tax-free shopping for tourists
• Cuts to fuel duty

Northern Ireland corporate tax rate

It is also worth keeping an eye out for any comments from the Chancellor about the Northern Ireland Executive’s plans to cut corporation tax to 12.5%. Now that the Stormont legislature is working again, this could be pushed to the top of the agenda, however, we don’t think that anything will be announced in this budget. Firstly, it would be costly. Second, a corporation tax cut in NI may need to fall in line with the global minimum tax rate, which is 15%. However, if this happens it would boost the UK’s competitiveness, and it could put pressure on the next government to reduce the corporate tax rate for the whole of the UK.

Elsewhere, the cut to fuel duty is expected by some analysts as it could be seen as a way to boost living standards and help remedy falling household incomes, but it could make a big dent in the Chancellor’s fiscal headroom and reduce the scope for some public sector spending announcements.

Public sector spending changes:

We think that the Chancellor will focus on tax cuts rather than spending pledges in this budget. This is a better strategy for the government, since they might not be in power in the coming months, as Labour still has a big lead over the Conservatives in the opinion polls. However, there still needs to be some update on spending measures.

• The NHS is expected to record an overspend of £700mn in this fiscal year, which the government may need to cover.
• Three local authorities have announced bankruptcy in this financial year, and nine others are in financial trouble. The government would need to spend £1.7bn on local authorities to bring spending back to pre-pandemic levels, but we doubt that they will do this.
• Aside from spending increases on the NHS, childcare support, foreign aid and defense, other public sector departments are expected to see real spending cuts starting from next April, to fund tax cuts that have already been announced.

Due to the above, we think that the Chancellor will find it difficult to announce further spending cuts in this budget to boost his pre-election fiscal giveaways.

OBR forecasts preview

The OBR will also announce their most recent economic and fiscal forecasts alongside the Spring Budget. The OBR’s November forecasts were fairly grim. They expected inflation to remain higher for longer, and not to fall back to the 2% target until the first half of 2025, a year later than previously forecast, the OBR also halved the long-term growth forecast. GDP for 2024 was predicted to be 0.7% this year, and they predicted a 1.4% rise in GDP for 2025. The OBR growth forecasts tend to be more optimistic than those from the Bank of England. For example, the BOE forecasts GDP for this year at 0%, although there are signs that the UK economy could beat these forecasts after recent economic data has beaten forecasts.

Inflation outlook: a roller coaster ride for UK price growth

The OBR could leave its GDP forecast relatively unchanged, however, it may recalibrate its inflation forecast, since it did not expect price growth to fall below the 2% target rate until H1 2025. However, the BOE now expects inflation to fall below 2% temporarily this spring, before moving higher again. The OBR may also factor in stubbornly high service price inflation in their latest inflation forecasts, which could leave them elevated in the medium and long term. Thus, the OBR, like the BOE may also forecast a roller coaster ride for inflation in the coming year, which could impact interest rate expectations, as the timing of a rate cut from the BOE becomes less clear.

Fiscal forecasts: are there blue skies ahead?

The fiscal forecasts from the OBR are also worth watching. Back in November, the OBR forecast that the tax cuts included in the Autumn statement would only have a minimal impact on growth, since then the UK economy is in a confirmed technical recession. However, the OBR also pointed out that the UK’s medium term fiscal outlook had improved materially, with borrowing expected to be £26.8bn lower than previously forecast. This was mostly down to a reduction in departmental spending.

There remains a question about whether these unspecified spending cuts are possible, especially with the NHS overspend for this fiscal year and the bankruptcy of several local authorities. Although spending is meant to fall in the medium term, it is still expected to be 3.1% above pre pandemic levels. If there is more spending pressure for the government in the medium term, the OBR could increase its expectations about the government’s future borrowing needs. Debt to GDP was also forecast to peak at 98.6% of GDP in 2024/25, and then fall back to 94.1% of GDP by 2028/29.

Fiscal headroom: will Hunt spend it all?

Fiscal headroom was forecast at £13bn in November, which is considerably lower than the average fiscal headroom of nearly £29.7bn since 2010. This highlights the tight fiscal situation that the Chancellor finds himself in. Fiscal headroom could fall substantially in future years if the government announces an expensive income tax cut in the March budget. However, if there is some positive movement in the UK’s fiscal headroom position, then it could help Northern Ireland to reduce its corporate tax rate, which may lead to lower corporate tax rates across the UK down the line. Since Jeremy Hunt knows that all signs point to a Labour victory in the next general election, he may be motivated to use more of the fiscal headroom for pre-election giveaways, which we will also watch closely.

Is this Budget worth the paper it’s written on?

To conclude, investors should focus on whatever election sweetener the chancellor offers the public in an effort to help the Conservatives as they face an uphill battle at the upcoming general election. However, we will also be watching the OBR forecasts closely, especially their growth forecasts, which have diverged with the BOE of late. Since there could be a change of government in the coming months, some may ask are any changes that are included in this budget futile, since the next prime minister is likely to have their own tax and spending agenda. The answer is probably yes. Thus, this could limit the amount of volatility this budget causes to UK asset prices, including the pound and bond prices.