UK Budget Response: A Path to Growth

On the spending side, key actions were taken with a focus on departmental spending. According to the OBR, around two-thirds of the spending increase will go to the day-to-day budget and less than a third to capital expenditure, with the NHS and education sectors expected to benefit the most. The incoming government has also set aside funds amounting to $2.3 billion per year over the forecast period to reimburse those affected by the Infected Blood and Post Office Horizon scandals. Meanwhile, it is estimated that strengthening winter fuel payment eligibility could save the government $1.6 billion a year.

To finance (some of) this spending increase, the government made good use of the threat of tax increases. The OBR estimates that Mr Reeves' tax changes will raise the tax burden by an additional $36.2 billion per year from FY25/26, taking the tax burden to 38.2% of GDP by the end of the forecast period. Epidemic. Notable changes include the NIC, which is expected to increase by 1.2pp from 13.8% to 15%, generating $24.5 billion per year from FY25/26, and the capital tax changes, which are expected to increase the total by $5.6 billion per year from FY25/26. . Among these, it is expected to generate 1.7 billion won in revenue by reforming the transfer tax, including lowering the capital gains tax from 10% to 18% and increasing it from 20% to 24%. It would generate $1.1 billion annually, including corporate and agricultural real estate and pensions. Meanwhile, additional changes to so-called non-dom plans are expected to generate about $2.5 billion. Lastly, if the value-added tax exemption on private school tuition is abolished from January, the annual increase will be 1.6 billion won from 2025.

However, the gap between expected revenues and expenditures already suggests an increase in the borrowing burden. Moreover, the OBR notes a high level of uncertainty about some expectations of revenues and costs, given the unknown behavioral responses to some measures. For example, individuals may change the timing of asset dispositions or transactions in response to capital tax changes. They may also move between different assets to take advantage of differences in effective tax rates, plan their taxes more effectively to reduce their effective tax rates by using reliefs, gilts or instruments to obtain more favorable tax treatment, or simply move their activities to the next country. You can also switch. Tax obligations are lowered. Infected blood and post office scandals can also cost more.

Although the focus of public finance fiscal rules has changed, borrowing is still higher.

Public finances have moved significantly compared to last March. Prime Minister Reeves was clear to point out that the OBR described a significant difference to the March forecast, including metrics that are not currently public, compared to last March. This means that comparing this first Labor Budget with the position stated in March does not imply the totality of the new Prime Minister's measures.

The Prime Minister took the opportunity to introduce new fiscal rules in his first Budget.

The goal is to see the current budget (deficit excluding investment) be in surplus by 2029-30, for three consecutive years, with 2029-30 being the third year of the forecast. The OBR currently forecasts a current budget surplus of $10.9 billion for 2027-28. Replace public sector net debt with public sector net financial debt (PSNFL) and see this decline as % of GDP by 2029-30. This marks the third year of the forecast, making it a rolling three-year goal. The OBR now predicts that PSNFL will fall from 2026-27. Reeves maintained his previous target that welfare spending should remain within predetermined limits and margins in 2029-30.

The Prime Minister also announced further changes to the Fiscal Charter, including the introduction of a fiscal lock that would require the OBR to scrutinize taxes or spending changes exceeding 1% of GDP. Increased transparency regarding spending pressures across various departments. We commit to regular spending reviews with a three-year outlook every two years. It also includes a commitment to hold major financial events only once a year, barring economic shocks.

But a simple comparison of the state of Britain's public finances now and in March shows a significant deterioration, made worse by the new government spending more than it has raised taxes. In the case of the old currency, public sector net borrowing increases again to 4.5% of GDP in 2024-5, the same as last year, from the 3.1% forecast in March, and decreases to 3.6% in 2025-6 and 2.9% in 2026-7. It is expected that you will. In the following years, it will be 2.3%, 2.2%, and 2.1%. Including this, borrowing over five years is expected to increase by KRW 142 billion, or about 5% of current GDP. The deficit ratio relative to gross domestic product (GDP) is expected to increase to 1.4 ppt, 0.9 ppt, 0.6 ppt, 0.6 ppt, and 1.0 ppt compared to the forecast in March this year.

This is also evident in terms of public sector net debt. It is estimated to total 98.4% this year (compared to 98.8% in March), but is expected to decline much more slowly than previously expected to reach the current 97.3% in 2028-9. This compares to the forecast of 94.3% in March (95.6% vs 92.9%, excluding BoE). Previous fiscal rules, which required debt to be reduced as a percentage of GDP by the fifth year of the forecast, provided few constraints for previous prime ministers as they only required debt to be reduced between years four and five. We are not particularly concerned that this will not be met as currently expected. However, the fact that overall borrowings are much higher is more concerning. At this stage, the Chancellor explains that the transition to PSNFL allows one to undertake worthwhile investments and consider the assets of such investments as well as liabilities. However, despite today's announcement, the risk of increased debt remains, as we believe the OBR's growth prospects for the next few years are optimistic, and any lack of growth is likely to strain tax revenues and lead to further borrowing.

The economy is expected to bounce back, but how quickly?

On the economic side, Premier Reeves has begun to deliver a budget that will stimulate growth over the long term, and on that front she has just delivered. In the near term, net fiscal easing is likely to boost growth, with the OBR revising its 2024 forecast to 1.1% from 0.8% previously and its 2025 forecast to 2% from 0.1pp. Of course, in the second half of the forecast period the OBR expects some contraction in private activity in an economy with little supply capacity, which will weigh on growth in the final years of the forecast period, while growth in employer NICs is expected to decline. Labor supply increases by an average of 50,000 hours.

Accordingly, the OBR lowered the growth forecast for 2026 from 1.8% to 2%, for 2027 from 1.5%, from 1.8% to 1.5%, and for 2028 from 1.7% to 1.5%. But the bigger picture, at least from the OBR's perspective, is that today's budget does not significantly change the level of GDP over the five-year forecast period compared to previous budgets, and that public investment should have continued given the growth in capital stocks and potential output.

There are doubts about whether economic activity will recover quickly over the next few years, but GDP levels will likely be weaker at the end of the five-year forecast period than the OBR currently expects. Yes, our forecast for the Bank Rate will fall by 25 basis points per quarter until mid-2026, to remain at 4.75% by the end of 2024, 3.75% by the end of 2025 and 3.25% by the end of 2026, and is slightly more aggressive than the OBR's new forecast. no see. However, this is because the OBR expects the inflation slowdown to deepen further over the coming quarters, with the output gap closing less quickly than it currently expects. Meanwhile, households are likely to remain relatively cautious over the next few years, even as mortgage rates decline and the recovery in household consumption is limited. We forecast growth of 1.2% in 2025 and 1.4% in 2026. Looking ahead, however, while we agree with the OBR that budget measures should help boost productivity growth, we doubt whether this will contribute to the assumed 1.7% trend growth rate. Financial watchdog.

Gilt takes a lot of work to digest.

Given these announcements, the expected volume of gold bond issuance has increased noticeably. This was due to the cash deficit (CGNCR) decreasing by $22 billion to $165.1 billion during the current fiscal year. Of course, this led to a 19.2 billion increase in planned gold sales, 3 billion of which was absorbed by the planned increase in government bond inventories. Overall, the market expected this scale of worsening borrowing, and accordingly, gilt short issuance increased by 3 billion, mid-cap bonds by 6 billion, long bonds by 9 billion, and index-linked bonds by 3 billion, with 8.5 billion remaining in allocation.

However, with borrowings higher than in the forecast period, the projected cash deficit (and repayment profile) over the next few years has also increased. CGNCR is currently expected to increase by 22 billion next year, 18 billion the next year, 21 billion won next, and 31 billion won next year. The gold leaf repurchase amount for 2026-2027 was also revised significantly higher to 24 billion won. Total gold issuance is expected to increase by 120 billion over the next four years compared to the forecast last March.

This results in extremely high gilt issuance. This year's gold sales compared to gross domestic product (GDP) are estimated at 5.6% of total GDP. However, taking into account the fact that the BoE is burning through its gold reserves through passive maturities and active sales, the net effect would be closer to 9% of GDP, similar to supply levels in 2008-09.

Market reaction favors stronger growth and more borrowing

Considering the importance of this budget market, there will always be a lot to consider. From a gold mining perspective, the market appears to be considering both increased issuance and the impact this may have on the BoE interest rate outlook. The 10-year gold bond yield reacted by rising 18bp, but is currently trading at 4.34%, 12bp higher. The yield on two-year gold bonds, which are suggested to be more important for interest rate outlook than for issuance sensitivity, rose 15 basis points to 4.31% at the time of writing. But the markets also appear to have adopted some of the prime minister's growth-focused approach. The FTSE 100 index was broadly flat, but the domestic economy-focused FTSE 250 index was initially up 1.8%, although it is now up 0.5%. higher.

In terms of overall market valuation, this can in no way compare to the disastrous mini-budget delivered under Liz Truss' brief reign in 2022. Gold bond yields jumped 33 basis points that day and continued to rise by 100 basis points over the next three sessions. Although the current gold foil response is incomparable, Sterling's response is even more impressive. In 2022, the pound fell 2.0% against the euro and 3.6% against the US dollar. Today the pound remains flat against the euro (a relatively solid 0.835) and is up 0.4% against the US dollar at $1.301.

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