Budget 2021 - a view from the market

This article forms part of our wider Budget 2021 coverage including expert analysis of the tax aspects which can be found on our budget hub.

The UK economic recovery is still in its early and fragile stages and the Chancellor has sought to nurture it in the near term with an extension of most existing fiscal support measures and the introduction of some new ones. But the warning signs are already clear beyond the horizon, both as to national debt levels and longer-term growth rates. That tension looks set to continue through the current parliament while the introduction of longer-term structural initiatives including 'freeports' and a 'green' investment bank get underway. Elsewhere lie the seeds perhaps of an early general election.

Financial markets were largely unchanged over the course of the Chancellor's well-trailed budget speech to the House of Commons - although the announcement of a return to a 25% corporation tax rate caused an initial frisson of concern!

Such movement as there was (notably the small rise in gilt yield) was consistent with a very modest reflationary boost in the early years of the forecast period - although the Office for Budget Responsibility cut its forecast for GDP growth in 2021 to 4% (from 5.5%), it increased the number for 2022 to 7.5% (from 6.6%) and brought forward the point at which it expects UK GDP to recover its pre-pandemic level to the middle of 2022.

The good news of course lies in the promise of renewed recovery as the benefits begin to flow from the various vaccination programmes, amongst which the UK's is one of the fastest in the world.

All else equal, modestly faster growth should mean modestly higher inflation and the OBR has raised its forecast accordingly to 1.5% this year (from 1.2%) rising to 1.8% in 2022 and then gradually rising to the Bank of England Target Rate of 2% by 2025.

As an aside to the Budget commentary, there is little in those forecasts (if met) to suggest any urgent need either for significant interest rate increases: the last Bank of England Monetary Policy Report (February, 2021) showed its projections for the UK Bank Rate staying close to present levels until 2024. The OBR is a little more hawkish and expects a rise to 0.25% by the end of 2023 and to 0.5% by 2026.

Given that Bank Rate is currently only 0.1% there must be some risk also, at least theoretically, of a cut into negative interest rate territory if there was any material disturbance to the UK's vaccine roll-out programme and/ or Prime Minister Johnson's "irreversible" relaxation from lockdown. The IMF has just published analysis suggesting that the so far eight years' experience of negative rates has proved sceptics wrong and that negative interest rates "have worked".  

Indeed, the macro conditions which set the background for this budget are at least as challenging as those for Alistair Darling, the Labour Party chancellor in 2009/10 as the Global Financial Crisis unfolded. The UK economy and those of all other countries today are coming to the end of only the third quarter of recovery from the deepest recession in many decades.

And while that recovery has been initially sharp, bolstered by the fiscal support measures, the recent pace has slowed under the weight especially of the further lockdowns at the end of 2020 and the start of 2021. As the chancellor made clear in his speech, the recovery is still in its early stages and thus vulnerable.

According to an OECD Weekly Tracker of Economic Activity, which we follow here at Simmons & Simmons, UK activity has recently been running at a rate equivalent to GDP contraction at an annualised rate of 8.4%, weighed down by the latest lockdown and, along with Germany (negative 8.3%) among the lowest economic activity rates in the G20.

Hence Chancellor Sunak's concern not to threaten such a fragile recovery with any premature fiscal tightening. Instead, rather than curtail existing fiscal support measures he extended the majority of them (albeit freezing existing personal tax thresholds) and the significant tightening measures he announced, notably the increase in corporation tax, are not due to take effect in the near-term - their virtue today is in their signalling.  In the short term, measures such as the "super-deduction" and a review of R&D tax reliefs are clearly aimed at getting businesses back on their feet and investing, in particular, for 'green growth'.

Clouds on the horizon - and an early election?

Given the scale of the pandemic in its economic effects, and the much greater human tragedy, any pace of recovery to pre-pandemic levels is to be welcomed - even although the rate of recovery for the UK and (on IMF forecasts) the euro-bloc is expected to be slower than for the 'V-shaped' global average, led by Asia.

But thereafter the OBR expects UK GDP growth of only 1.7%, 1.6% and 1.7% in years starting 2023... those are low and reinforce concerns around low U.K. productivity and thus low 'trend growth'.

They also reinforce concerns over debt/GDP levels - the other side of Sunak's balancing act with nurturing growth. Despite the drop back in GDP growth rate after 2022, the OBR projects the ratio of public sector net debt-to-GDP to fall from a peak of 110% in 2023/24 only to some 105% by 2025/26.

Which begs a question: if growth rates are falling and debt/GDP is also falling then net debt must be falling faster - which points to a rising tax burden. OBR forecasts suggest that by 2025/26, corporation tax receipts will have risen to over 3% of GDP - the highest level since 1989; and that the overall tax burden (take) will have risen to over 35% of GDP - the highest level since 1969.

Among many other implications is this one by way of a final thought for this section: newspaper headlines calling out record high tax rates would be an unwelcome backdrop to a General Election, currently scheduled for December 2024.

Watch this space for developments on the Fixed-term Parliaments Act 2011 which determines the fixed 5-year interval between elections. It is a commitment of the Conservative Party manifesto to repeal that Act and a Bill to achieve that is currently working its way through the UK parliament. Spring 2024 or even Autumn 2023 anyone?