UK Budget giveaway fails to dispel growth fears

Portfolio manager Oliver Blackbourn responds to the latest UK Budget, addressing the market’s concerns that higher inflation could become ingrained in the UK, and fears of lower growth over the longer term.

Key takeaways:

• The Office for Budget Responsibility has indicated an inflation rate in the UK of 4% over the next 12 months.
• Huge government spending has boosted growth over the last 18 months, but tighter fiscal rules represent a drag that spending from other parts of the economy will need to replace.
• Investors appeared to see little to buoy the longer-term UK economic outlook as yields slipped lower during the speech and the curve flattened markedly.

The gilt market was clearly not impressed by UK Chancellor Rishi Sunak’s speech, with yields seeing another leg lower during his delivery, suggesting a less positive outlook for the UK economy. Investors remain concerned about both rising inflation and the future fiscal drag on growth as spending from the pandemic era rolls off. They received little comfort as Sunak pointed to a level of inflation far above the Bank of England’s target over the next year and his new fiscal rules are a concern for those worried about the impact of the sharp contraction in government spending.

The Chancellor stated that the Office for Budget Responsibility has indicated an inflation rate in the UK of 4% over the next 12 months. While much of this is being driven by global trends, the fear is that it could become ingrained, particularly as the labour market continues to tighten. The increase in the living wage may put further upward pressure on salaries more broadly, adding to the Bank of England’s headache and pouring extra fuel on the inflation fire.

In contrast, markets clearly have concerns about the medium-term outlook for the UK economy as they are already pricing in an interest rate cut from a peak just a year and half away. A commitment to deleveraging is unlikely to comfort those worried about a return to the low growth levels seen in the last decade. Growth has been boosted over the last 18 months by huge government spending, but the reduction of the deficit is a drag that spending from other parts of the economy will need to replace. The Chancellor suggested that he feels the economy will need to stand on its own two feet rather than be propped up by the government.

Investors appeared to see little to buoy the longer-term UK economic outlook as yields slipped lower during the speech and the curve flattened markedly. Although global yields were falling at the same time, the move lower in the UK gilt market was far more pronounced. Sterling was volatile during the Chancellor’s address but broadly weakened against the euro and US dollar, although it remains stronger so far in October. Unusually, the UK equity market appeared to be broadly moving in the same direction as the pound during the day’s trading, although this was over a very short period. A flatter yield curve appeared to be helping defensive sectors, such as utilities, real estate and healthcare, outperform on the day.