Autumn 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 Autumn Budget and Spending Review could have had huge potential significance, although financial markets are so far unimpressed. Faster growth this year created the headroom for increased spending plans but some of the positive factors are likely transient. An increased tax burden has been left to take the strain, projected to reach levels not seen since the former USSR launched its first Sputnik satellite. Any disturbance to economic growth next year, perhaps from COVID or overly aggressive rate hikes, could take us back to WW2 levels of taxation, creating a difficult backdrop for the next general election, which could come as soon as 2023.

The UK Budget of autumn 2021 was always thought to be significant as the first Budget able to give a glimpse of the end-of-the-beginning of the COVID-19 pandemic including inevitably some sighting shots on the answer to the question: "who pays for the COVID emergency measures?".

Significant also because it coincides this time with the (roughly) triennial spending review at which the government sets out its longer-term plans for overall and departmental spending.

In the end, so far as the immediate financial market response, it proved something of a damp squib. While the Chancellor delivered his speech the FTSE100 market barely moved, gilt yields eased by only a handful of basis points and sterling nudged a fraction higher against the dollar.

That muted response may have been in part due to the lack of material surprises (beyond the easing of cuts to Universal Credit) given the degree of briefing ahead of the event. If so the trends over the prior week (covering the period of pre-briefing) may be more instructive: gilt yields and sterling down and FTSE100 up somewhat more decisively. It's a pattern consistent with easing fears of rate hikes.

Through that lens, perhaps the most significant numbers produced today were those from the Office of Budget Responsibility (OBR) which raised its GDP growth forecast for the current year but cut it in the following year (2023) followed by a sharp slowdown to 2% or below from 2023 onwards.

That growth profile does two things: it provides greater leeway for increased spending in the near-term and lowers forecast inflation back to the Bank of England target rate of 2% by 2024 assuming only "modest" monetary tightening (rate increases), a "stabilisation" of energy prices and an easing of "supply bottlenecks" - taken together sufficient to offset the fiscal easing announced today.

But the growth profile also fires a cautionary shot across the bows of rate setters and indeed across the bows of expected increases in tax revenues as a proportion of GDP to fund the various initiatives announced today.

OECD data show its measure of consumer confidence falling recently in the UK and most major economies around the world. In a sense that's hardly surprising after hitting sometimes record highs ahead of the transition from the sprint of the recovery phase from the pandemic to the marathon of longer-term, steady-state growth rates.

Falling consumer confidence is not a robust backdrop to hikes in interest rates and it may be that even modest ones, as expected in financial markets for the UK, to dampen the inflation spikes could disturb what prove to be still fragile growth forecasts for next year - and with them the tax revenues anticipated in today's announcements.

Productivity clearly plays its part in the overall mix and here the picture is decidedly mixed. The OBR's new forecasts show an encouraging improvement in the degree of COVID "scarring" to UK GDP - from a hit of 3% to GDP as at its March 2021 forecasts to 2% in the current set and an important contribution to the additional headroom used by the Chancellor in his increased spending commitments today.

And more than half of that improvement came from an improvement to productivity - a vital component in the Prime Minister's ambition to "build back better" towards a "high wage, high skill, high productivity economy".

But the factors behind that improvement may prove transient: they include the assuaging impact of government support schemes - now being withdrawn - and the "potential boost ... from the closing of less productive firms."

Lasting improvements to productivity have defied all efforts since the Global Financial Crisis (GFC); the Office for National Statistics (ONS) calculates that, by the time the pandemic hit in early 2020, productivity had more or less flat-lined around its level immediately prior to the GFC for the whole of the intervening decade. Without lasting improvements to productivity, it is hard to see a general increase in real terms wages across the whole economy and that could come back to haunt the government as the next general election draws closer - perhaps as early as 2023.

Altogether the Chancellor, especially a Conservative Party Chancellor, has a delicate balancing act for today's announced spending plans already push the UK's tax-to-GDP ratio up to over 36% by 2026/27 ... a full 1 percentage point higher than the OBR's March forecast and the highest level for almost 70 years - since the time of Harold Macmillan as UK Prime Minister; since the former USSR launched Sputnik and since the USA sent its first troops to Vietnam.

If growth falters in 2022, perhaps from overly aggressive rate increases or renewed localised COVID lockdowns, that tax burden could rise further still and closer to WW2 levels!