Going for (green) growth

We assess the implications of the UK Budget for bond markets and the wider economy.

• The immediate priority is to provide further economic support as the country emerges from the pandemic.
• The main revenue-raising measures to reduce the deficit will be phased in later in the government’s term.
• The debt/GDP ratio is expected to keep rising, albeit more slowly than recently, until 2023/24.
• The Debt Management Office (DMO) intends to issue a minimum of £15bn in new ‘green gilts’, confirming that the state intends to play a more active role in the ‘greening up’ of the economy.

Following the example set by (among others) the US and India, yesterday’s UK Budget saw Chancellor of the Exchequer Rishi Sunak confirm that financial austerity is now a fading memory for the country. Meanwhile, as widely anticipated, greater levels of state intervention were announced to help facilitate the transition to a greener economy.

Further economic support

The immediate priority was to provide further economic support as the country emerges from the pandemic. Yesterday’s additional announcements on extending furlough, self-employed and business help in the form of grants and loans amounts to a further £65bn, mainly in the current year, with some support extending into 2022. The main revenue-raising measures to reduce the deficit will be phased in, with personal tax allowances no longer increased in line with inflation after this year, and a hike in corporation tax from 19% to 25% occurring in 2023. As a result, the debt/GDP ratio is expected to keep rising, albeit more slowly than recently, until 2023/24, when it will peak at almost 110%.

None of the measures announced have greatly surprised bond markets; gilts have slightly underperformed other (falling) government bond markets. Spending now in the hope that growth and future tax rises will eventually lead to a decline in debt/GDP will, at the margin, contribute to upward pressure on gilt yields and gilt supply; although the associated gilt issuance target for 2021/2 is towards the higher end of estimates, at £295.5bn, it is still a far cry from this fiscal year’s expected £485.5bn. We don’t expect bond investors to lose too much sleep over this – as long as inflation expectations do not rise too much.

Mixed inflationary outlook

In terms of the budget’s potential impact on inflation, we see a distinctly mixed bag. Further fiscal stimulus should add to upward inflationary momentum, but the cancellation of proposed excise duty increases and the continuation of lower value-added tax (VAT) rates on the hospitality sector will mean that base effects are less pronounced, while further support for the housing market will possibly increase the wedge between retail price inflation (RPI) and consumer price inflation (CPI), as housing costs feature in the former, but not the latter. Five-year inflation breakeven rates have climbed about 0.4% so far this year, and added another 2 basis points as the chancellor spoke. Index-linked gilt issuance will rise in percentage terms compared to this fiscal year, to 11%, but again, this is within the range of market expectations.

The impact on public finances of some of the other growth-oriented measures (free ports, tax super-deductibility of capital investment, easier entry for highly skilled workers, etc.) will take time to determine, and will be partly offset by the hefty increase in corporation tax from 19% to 25% in 2023.

Green and sustainable bonds growth

The change to the Bank of England’s remit, which requires it to set policy reflecting the importance of environmental sustainability and the transition to net-zero carbon emissions, plus confirmation that the Debt Management Office (DMO) intends to issue a minimum of £15bn in new ‘green gilts’, confirms that the state intends to play an active role in the ‘greening up’ of the economy. Both developments should add impetus to the number of corporate green and sustainable bond issues.

This is a financial promotion. These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This material is for professional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those securities, countries or sectors. Please note that holdings and positioning are subject to change without notice.

Authors

Howard Cunningham

Portfolio manager, Fixed Income team