Muted market reaction as UK budget puts off difficult decisions

There was some market volatility yesterday as the details of the UK budget were leaked early. This initially put sterling under a little pressure but, in the end, sterling actually gained somewhat once the full budget was revealed. Sterling is now trading at about 87.5p to the euro and above $1.32 against the dollar. The UK Budget turned out to be somewhat of damp squib with tax increases put off until later in the life of parliament and other actions being kicked down the road somewhat. The euro, despite some intraday moves, is up just a touch on the dollar this morning at around $1.1590 though it did trade as low as $1.1550 at times and as high as over $1.16.

While the market reaction to the UK Budget was muted, UK yields did move down yesterday. 10-year gilts were down about 7bps to 4.42%, outpacing 10-year US treasuries and 10-year German bunds which were more or less unchanged. At the shorter end of curve, 2-year UK yields fell by 3bps while similar term US and UK yields were unchanged or marginally higher. The softer than expected UK Budget means that growth next year will not be hampered by austerity measures – in fact, overall the Budget surprisingly loosen fiscal policy slightly next year- so it was not a game changer in terms of impact on the Bank of England outlook.  Nonetheless markets are pricing in two 25bps rate cuts by the Bank of England by next April, most likely starting with a 25bps cut at the next meeting in December.  Equities continued to rally strongly, ahead of US markets closing for Thanksgiving today, with the S&P up another 0.7% for the day to back over 6,800 – less than 1% off its record high. The IT sector was, once again, the darling, up 1.3% on the day, though there were solid gains in most other sectors too. There were further gains for European indices also with the Eurostoxx up 1.5%, while the less decisive than expected UK budget did nothing to put off FTSE investors with that index up 0.9%.

The UK budget was leaked early, accidentally, in a dramatic fashion by the OBR but the details turned out to be less dramatic than expected. It was expected that the OBR’s GDP growth revisions and Chancellor Reeves’ adherence to her own fiscal rules would lead to an overall required adjustment of £30-£40bn (1%-1.3% of UK GDP) but, in the event, favourable OBR forecasts for future productivity gains and optimistic Government forecasts of spending restraint in the next number of years means that painful sizable tax raises were put off. There was a range of tax increases on property, savings, gambling and mansions alongside freezing income tax bands and increased national insurance on pension contributions but most of the impact of this will not be felt for a number of years. In fact, the UK budget is mildly stimulatory, to the tune of about 0.2% of GDP over the next two years. While this Budget was much talked about and watched, it turns out that the sharp up front fiscal adjustment has been put off and there is nothing in yesterday’s announcement that will have shifted the dial substantially for the Bank of England or gilt investors. However, the Labour Government may regret not taking this opportunity now for a painful correction if the optimistic forecasts for growth, productivity and spending restraint turn out to be less than accurate and they face into Budgets closer to an election with the need to placate the bond market by fixing the public finances then.

The lasted Fed beige book indicated that economic activity in the US was little changed. The report said that district’s outlooks were largely unchanged’ though some saw ‘an increased risk of slower activity’. Employment ‘declined slightly’ with about half of districts reporting weaker labour demand with companies limiting hiring rather than widespread layoffs for now. Tariffs remain a concern for businesses but plans to raise prices in the near term were mixed. Interesting, several districts including New York note that spending appeared resilient among upper income households but weaker among the low and middle income earners, evidence the US economy is in a, much talked about, K shape with higher income households doing well but much weaker for households lower down the income chain. The report has little impact on pricing of the next Fed rate cut, with an 80% change of a rate cut next month now priced in.

Could be a quiet day today with US markets closed, the main data will be EU Commission confidence data and ECB minutes.