UK Budget special: What to expect and the market reaction

Sterling and UK stocks moved higher on Wednesday, as we wait for the UK Budget. At 1230 GMT, the Chancellor will deliver the UK budget. This has been much anticipated, and there have been multiple leaks about what to expect including:

Giveaways

• National insurance is expected to be cut by 2p; this is the second cut. Could the chancellor announce that the cut comes into force from this April – before a general election?

• Freezing fuel duty, including a 5p cut in petrol duty that was initially announced in 2022.

Tax increases

• Introduction of a vape duty.

• Increase in tobacco duty.

• Removing tax breaks from second homes used as holiday rentals.

•  Extending the levy on oil and gas profits from the North Sea.

• Scrapping or scaling back non-dom tax rules.

Other

• Introduction of a British ISA.

As you can see, the list of tax increases dwarves the number of giveaways and sums up the Chancellor’s predicament: the UK is in a tight fiscal position. The amount of ‘fiscal headroom’ is tight and at approx. £20bn, is lower than the average of £30bn since 2010. It is also lower than the £50bn anticipated if the UK’s economic growth had kept up with its developed market peers in recent years.

The Chancellor is likely to promise more tax cuts in the next Parliament: including income tax cuts, inheritance tax cuts and stamp duty cuts, but only if you vote for the Tories at the next election.

It is also worth watching the tourist tax, which could be scrapped today. The Chancellor had asked the OBR to review the effectiveness of this tax, with some retailers saying that it was causing harm to their sales and making the UK a less attractive tourist destination than its European peers.

Public spending plans: is this a new austerity budget?

This is where things could get messy and very difficult to predict. The government is most likely going to have to plug the NHS’s deficit this fiscal year to the tune of £700mn, which reduces the chances of any significant increases in public spending.

There is a chance that Jeremy Hunt could sacrifice the non-ringfenced public sector, for example defense, in order to build a war chest for future tax cuts if the Tories do win the next election. Public spending is only expected to rise by 1% from 2025, this could be reduced to 0.75%. This would leave Hunt open to accusations that this is an ‘austerity budget’, however, he may accept this in order to focus on the potential for affordable tax cuts down the line.

As we have mentioned, there are plenty of evidence that voters prefer increases to public spending rather than tax cuts, but that does not appear to be Rishi Sunak’s game plan for this election.

What else to watch in today’s Budget:

• OBR forecasts – just how likely are tax cuts, how much fiscal headroom will there be in future? Will the OBR revise their GDP forecasts to be more in line with the BOE?

• Inflation forecasts – will the OBR’s inflation forecast highlight that the government’s spending plans from 2025 onwards will actually be a deep public spending cut, when adjusted for inflation?

• The tax burden: this is likely to grow to a post-war high, if future fiscal headroom is constrained, then it could knock the credibility of any promises from the chancellor to cut taxes in the next parliament.

• The chancellor needs to be careful that this Budget is not considered inflationary, as voters have been hurt by the cost-of-living crisis. It could also reduce the chances of rate cuts from the BOE later this year. Interest rate cuts may not impact the Tory faithful who are older and may own their homes outright. But, if Sunak is to try and win back votes from Labour, then this Budget cannot be seen as a block to interest rate cuts from the BOE. This could constrain what the chancellor can do, even more.

The market impact

• Stocks to watch: UK homebuilders if there is a pledge to increase the annual number of homes built, self-invest platforms if there is the introduction of the British ISA.

• Overall, European stocks are generally stronger on Wednesday, but the UK’s FTSE 100 is one of the weaker performers.

• However, the FTSE 250 is at its highest level since early January, as we lead up to this Budget.

• The companies leading the FTSE 250 higher today include Greggs, on the back of stronger results, and holiday firms, on the back of an upgrade from Morgan Stanley for Tui, who stated that solid demand for foreign travel could boost this stock, as its valuation remains low.

• So far, sectors that could be impacted by the Budget are not leading UK stock markets higher.

• The pound is continuing its march higher on Wednesday, and GBP is the strongest performing currency in the G10 so far this year. We do not anticipate that there will be anything in this Budget to knock the pound off its pedestal.

• Gilt yields are also marginally lower this morning. But the 2-year Gilt yield is approx. 30 basis points higher since the start of the year, as global interest rate expectations have been scaled back. We do not see this Budget as having a major impact on UK bond yields, unless the OBR forecasts suggest that any new tax measures are inflationary.

• Overall, we do not think that Jeremy Hunt will do a ‘Kwasi Kwarteng’ and drop any tax bombs that could blow up the Gilt market or the UK pensions industry later on Wednesday. This ended Kwarteng’s government career, and the Liz Truss government, and Hunt will be happier if this Budget is a low volatility event for financial markets.