Supplement 050323 – Fiscal Headroom?

Mar 5, 2023

The Resolution Foundation, a think-tank, said the improvements represented “a fresh tonic to the chancellor as he prepares to deliver his spring Budget in three weeks’ time”. – Financial Times, Chris Giles


Welcome to the supplement – I’d love to say spring is nearly springing, but it doesn’t feel like that yet, does it? Still a couple of weeks until the official start of spring anyway. Looking forward to not looking at any minus numbers on the thermometer! The temperature is partially topical for today’s supplement, because of the (comparatively) good news about the “Fiscal Headroom” that has appeared – to the tune of £30-£31bn – within the Chancellor’s figures for the upcoming budget (under 2 weeks away now).


There’s also a fairly major blunder by the OBR (Office for Budgetary Responsibility) that can’t not be considered here. It’s too big to “let them off”. Don’t get me wrong, I’ve made some mistakes in my time, but this one is a doozy. It gets a whole one line in most articles that have reported it, and a paragraph in the FT:


“The OBR made an error in its assessment of the monthly profile of the public finances in the Autumn Statement, and only changed its spreadsheet on Monday. Previously the fiscal watchdog had said borrowing of £9.2bn was likely in January, a figure it revised on Monday to a surplus of £0.4bn.”


You don’t need to be eagle-eyed to notice that’s a fair mistake. Nearly £10 billion of mistake. The reasoning is a really significant assumption and shows you what happens when you make assumptions. The next paragraph:


“The mistake arose because the OBR wrongly assumed Treasury payments to cover Bank of England losses on its quantitative easing programme would increase public sector borrowing in January. The payments in fact have no effect on borrowing.”


Quite a boo-boo. But perhaps this is unfair on the OBR – after all, what they assumed is what would be expected to happen. So the question becomes, in reality, how is this £9.6bn difference accounted for? Has it just evaporated? (Much larger sums evaporated during Covid, via different mechanisms, in the heat of battle). The Bank’s losses are not being covered by the Treasury – so how can the Bank lose money? Well – it makes the money after all………this is the stuff that fuels the debates around ponzi schemes at the government level!


Today though I wanted to focus on the headroom. It has been a very very active week at HQ. One day this week I wondered if I had missed some news – the leads really were very much like buses. Three deals totalling 8 properties in one day (all converted on the day – very nice!). This level of transactable deals at conservative prices has simply not been seen since 2019, from my perspective. A mixture of the good old-fashioned fast stuff, and some creative structuring as well. 


This isn’t a million miles off what I predicted. It might not look so bad in the new year, but the news is slow to percolate and Nationwide have reported 0.5% decline in house prices for February with that down 1.1% year-on-year, and 3.7% lower than the August peak. I’m fairly sceptical on this in certain areas, where it remains a seller’s market; however it certainly seems accurate for some areas or even a little light (that is, of course, the nature of a nationwide average). 95%+ of people are not forecasting, they are reacting and are prone to listening to the media. I still remain unconvinced that a double-digit drop is on the cards this year though, simply because of economic outperformance and wage inflation – and the fiscal headroom news.


The headroom – the extra £30bn. Similar (and larger) figures were forthcoming from some recent Sunak budgets of the past couple of years. Don’t misinterpret this. This is good news, comparatively, but not money that the Government really has to spend. However, it is in the budget, so to speak, so it COULD be spent.


There’s some easy wins here coming for Jeremy Hunt. This money has been “created” (or this headroom, more accurately), by the near-£10bn miscalculation above; also by lower energy prices and lower spend, consequently, by the government, on the energy bill guarantee – also, recorded borrowing from April – December 2022 was revised down by £5.8bn (eye-watering, isn’t it!). January was also spectacular compared to expectations, and the expected £7.8bn deficit was actually a £5.4bn surplus (a monstrous turnaround of £13.2bn in just one month!).


Things are better than expected. That’s been the message of the supplement in the past few weeks. It COULD be the case that the downturn is just going to take a bit longer to emerge – that seems particularly likely; but also the economy is more resilient than expected. The energy price adjustments are very welcome, and the headroom that Hunt has means that an extension of the energy price guarantee for 3 months, rather than an extension of it to £3,000 for the average household, could now be on the cards. Easy political point-scoring with no skill from the government – but this is why, arguably, you plan for the worst and hope for the best.


I, personally, remain concerned. A survey of a number of countries by Bloomberg recently reveals that by some majority, the significant worry is that the markets in general are being too complacent about the Russia and Ukraine situation. There is still a larger stranglehold on oil that could be exploited, for example. The likely scenario is now overwhelmingly seen as the war in a near-stalemate style position, for several years potentially. Further energy shocks – when China defrosts (rather than roaring back into life – the lessons were there from other economies, let’s face it) and increases current demand for energy, the overall global scarcity of fresh sources of energy (when we deal in reality, and numbers, rather than ESG and renewable hype, which has no chance of even getting to 50% of global energy demand within 30 years/by 2050 – without major breakthroughs in geothermal, most likely, and/or a total embracing of nuclear power – which of course is not classed as renewable – is a fact rather than an opinion) will push prices back up, perhaps to a crisis-style point and make what’s happened thus far look relatively benign with energy prices.


This is more of a 5-10 year view, though – Chinese demand won’t be back to full throttle for many months yet, and their own industriousness and speed at which they are building nuclear plants (for example) puts them in a strong position, but their hunger for global natural resources puts the world market on a knifeedge. Their own problems with falling population and stuttering economic growth at least don’t make them by definition a country with ever-increasing demand like so many of the developing economies in the world, but the situation is definitely one to monitor closely.


So – there’s more money in the coffers than expected. Ridiculous though it is these days, £30bn will not be considered “much”. The energy bill guarantee mentioned above will “only” use a couple of extra billion, or £2.5bn – so, there’s room for (for example) improved public sector pay settlements. Will that happen? Let’s see. There is an ideological bent in the ruling party which makes this unpalatable, but the public transport freeze planned for March will not help many who are unafforded the privilege of working from home. That sits poorly with me – just like during Covid, the front line workers suffer the most. It genuinely doesn’t seem fair.


Sunak, when in a similar but larger position, because the Covid forecasts on the immediate economy were far too bearish, spent barely any of it. Less than 20%. With that sort of attitude potentially taking itself into this budget, or that being number 10s influence, what could possibly change it? Well, the looming election which much be playing very large on the minds of the Tories by now. Too early for a giveaway? Maybe. Tax still needs to go up, not down, simply to help control inflation (and yes, it really is very painful to write those words!)


The longer term implications of a public sector pay rise are questioned by the Institute for Fiscal Studies (which attempts to steer clear of political ideology, and does a pretty reasonable job of doing so). In the short term, yes they can be afforded – but permanent rises are permanent, of course, and that means finding that extra money every year ad infinitum. Whether that can be afforded is questionable, although it is clear that something needs to be done.


I suspect the only solution is likely to be multi-year, potentially 5 or even 7 year deals, similar to the way that Hunt has theoretically made the books balance since his appointment as chancellor. “All is fine as long as we freeze tax thresholds and LHA until 2028” – Cheers, mate.


The energy bill news overall, if it comes to fruition, is VERY helpful for inflation control. We were looking at a guaranteed move upwards in April, but the cheaper prices (it’s all relative – energy is still far more expensive than pre-covid) mean that this may well be contained for households and manageable for businesses, rather than the sector-decimator that it was framed as back in October.


Hunt seems to have a plan for Autumn tax cuts, particularly for businesses – and is urging patience. I’m not sure I see likely good news coming into winter, personally – we are underestimating quite what we’ve got away with, from the truly uncontrollable temperature perspective – with another temperate winter behind us (and yes, I have seen the forecast for next week – but given the date, we are right at the end of the trend here). October forecasts have very rarely looked good in recent years – strip out the Covid effect, and still, it is almost never good news going towards the slowest economic quarter of the year (Q1).


Still, recession avoidance is starting to look very possible. We do have a drop in output for Q1, that is highly likely; but if Q2 holds up, we are still just about bumbling along and as a whole, coping with the massive inflation that we’ve faced. That’s a truly incredible result, and will be MUCH more luck than judgement if this administration gets away with it – regardless of the political colour of the next administration, some inflation still looks very attractive to lower the purchasing power of the last slug of massive debt taken on during the pandemic which is still increasing now. £30bn extra isn’t because we aren’t borrowing, to be clear!


The bonds have adjusted again – slightly downwards, more so in the US which might well drop the yields again here on Monday morning on the opening bell – as institutions remain optimistic that inflation is under control without TOO many more rises in the base rate. As I’ve said all along – the question really in everyone’s minds should be duration, not peak – and stronger for longer still looks likely, although energy price movements are helping a lot. Mostly, the plan is praying for no more wars – always a good plan – but with no realistic means of controlling any of those risks. 


The following advice, much of which has been espoused over the past weeks and months, still applies:


  • Fix now, secure rates, switch products if the rates go down before you get to an offer
  • Don’t sit and wait for “much lower rates” – that’s only happening if we have a meltdown, which will also see credit conditions tighten
  • Be prepared for several years at these elevated rates before we get a really meaningful drop – plan for the worst, hope for the best
  • Cashflow is king more than ever
  • The best leads are coming from those who are on base rate trackers, who have at least 2 more meetings of PAIN ahead of them – follow those up!
  • Don’t overextend yourselves at this time – stay liquid
  • Stack the deals at 6% interest rates to be cautious
  • Patience is a virtue – there are more deals around at the moment than I’ve seen for the past 3 years
  • Asset management is not optional – rents need reviewing
  • Don’t be scared to sell off assets that do not have investment grade yield – it is still very feasible to cash in on the Covid pricing boom before prices may take a tumble – I’m not seeing it personally but that doesn’t mean it can’t happen – again, plan for the worst, hope for the best
  • Stay financially attractive – housekeep your credit files
  • Consider cutting and reviewing your discretionary spending if you don’t already – budgeting is extremely important in such times


I’m hopeful that helps – as always, more than anything – keep calm and carry on…….