Supplement – Head Down and Driving

Nov 20, 2022

“Never can true reconcilement grow where wounds of deadly hate have pierced so deep…” –  John Milton, Paradise Lost


Welcome to the supplement in an eventful week for the economy and the UK as a whole, with inevitable consequences in the property market, prices and rents. We’ve seen absolutely classic politics this week – the toughest choices I can remember, on a macro scale, but the ruling party stuck between the devil and the deep blue sea (some thanks to the incompetency of their predecessors, some thanks to a hangover of the gigantic stimulus received by the country during the pandemic) – and as always, we need to remember that we do need to wait for the details, rather than just the high-level headlines from the budget. Globally we went past our 8 billionth person, and by all accounts we have 9 billion and 10 billion to look forward to in comparatively short order.


Market wrap and inflation

Let’s just cover the other news first of all; inflation for October was announced and overshot the forecasts to the upside, 11.1% for the CPI versus a forecast of 10.7%. This did not immediately filter through into higher gilt yields, on the day of the announcement (Wednesday) which I found to be a very interesting phenomenon – a completely different reaction to the USA missing the same forecasts to the downside last week – meaning one of a few things. Firstly, that the current forecasts on the base rate are still unchanged even if inflation is a little higher, or a little more persistent. Secondly, that the peak is less important than the persistence, and a higher rate means a bigger rise at the December MPC meeting of the Bank of England, controlling inflation more aggressively/getting on top of it. Possibly. In reality, as often, the movement of markets is very difficult to predict and there are dozens of factors going on in any one day.


Gilts – proof once again I’m not a bond trader

Even more strangely, yields THEN started to move against the government in preparation for Hunt’s speech (The Autumn Statement, i.e. the budget) – presumably as some of the news was leaked. The yields on the 5 year bond moved around 12-13 basis points during the speech, presumably on news that included the softening of the energy price cap from £2,500 per year (effectively £2,100 thanks to the £400 household rebate) to £3,000 per year, and also presumably on the news that the budget did not contain some of the disinflationary tactics that were expected by the markets. More on this later.


There are a number of formats that are used in the press, and wider media, by those analysing the budget. I have, in the past, preferred a line-by-line detailed analysis to try and not miss too much and just to highlight what I see as the key points, and I am going to use the same methodology today, but solely on the executive summary – the entire document is 70 pages and I’m not sure anyone would forgive me for replicating the whole lot!


The meat in the sandwich – budget commentary

So……here we go: (original text in Italics, my commentary in BOLD)


The Autumn Statement 2022 comes at a time of significant economic challenge for the UK and global economy. Putin’s illegal war in Ukraine has contributed to a surge in energy prices, driving high inflation across the world. No doubting that the war has contributed significantly, just as always happens in similar situations – this one is more real to many in Europe specifically because it is so much closer to home, and the reality is a multi-commodity disruption – oil, natural gas, and therefore electricity – in Europe, gas is actually much more damaging than oil price movements seen in previous conflicts in, for example, the middle east – and that’s the reasoning. To blame the war alone would be inaccurate – the world has a larger energy crisis looming in terms of increasing demand with relatively static supply, or at least supply not increasing in the same proportion as overall demand is.


Central banks are raising interest rates to get inflation under control, which has pushed up the cost of borrowing for families, businesses and governments. Growth is slowing and the International Monetary Fund (IMF) expects a third of the global economy to fall into recession this year or next. This comes against a backdrop of higher levels of government debt due to the economic impacts of the COVID-19 pandemic and current energy crisis. This is one characterisation of it which ignores the responsibility of the government in how they reacted to the pandemic, of course – but this is politics! 


Debt interest spending is now expected to reach a record £120.4 billion this year. A significant part of this is thanks to index-linked gilts i.e. government bonds that pay more interest when inflation is higher, more than 25% of this figure.


These factors have contributed to a significant gap opening between the funds the government receives in revenue and its spending. The government’s priorities are stability, growth and public services. Pleased to hear it framed in this way, frankly.


Economic stability relies on fiscal sustainability – and the Autumn Statement sets out the government’s plan to ensure that national debt falls as a proportion of the economy over the medium term. This will reduce debt servicing costs and leave more money to invest in public services; support the Bank of England’s action to control inflation; and give businesses the stability and confidence they need to invest and grow in the UK. To achieve this aim, the government has reversed nearly all the measures in the Growth Plan 2022. Note the overall difference in the rhetoric here. A reliance and recognition of working WITH the Bank of England. The reversal of the disastrous measures proposed in September 2022 makes sense – but I’m not sure the path for growth has clearly been paved by this statement.


The Autumn Statement sets out further steps on taxation and spending, ensuring that each contributes in a broadly balanced way to repairing the public finances, while protecting the most vulnerable. The government’s approach to delivering fiscal sustainability is underpinned by fairness, with those on the highest incomes and making the highest profits paying a larger share. The Autumn Statement reduces the income tax additional rate threshold from £150,000 to £125,140, increasing taxes for those on high incomes. Those who campaign for equality and levelling up will be somewhat split here. This disadvantages a small percentage of earners – between 2 and 3% – but does nothing to tax wealth, which is becoming more and more “attractive” to the masses thanks to large wealth transfers thanks to Covid stimulus, but very difficult to actually implement – and if you think this sort of move is not very “Conservative”, I’d encourage you to think about the difference between taxing income and taxing wealth.


Income tax, National Insurance and Inheritance Tax thresholds will be maintained at their current levels for a further two years, to April 2028. The government will also reduce the Dividend Allowance and Capital Gains Tax Annual Exempt Amount. Businesses must also pay their fair share. The Autumn Statement fixes the National Insurance Secondary Threshold at £9,100 until April 2028. This is the biggest tax raid of them all. The silent one, taking 5 and a half more years of inflation and getting all of the uplift into the Government coffers. This is worth dozens of billions over that period – and everyone paying income tax of any kind – so anyone declaring an income above £12,570 – will pay something here in real terms. The can is so far down the road on this we can’t even see it anymore. 


The government will implement the OECD Pillar 2 rules, to deliver a global minimum corporate tax rate of 15%. R&D tax credits will be reformed to ensure public money is spent effectively and best supports innovation. More details are needed here – R & D tax rebates are widely documented to provide great returns to Governments, but without detail we do not know exactly what this means.


The Autumn Statement sets out reforms to ensure businesses in the energy sector who are making extraordinary profits contribute more. The Energy Profits Levy will be increased by 10 percentage points to 35% and extended to the end of March 2028, and a new, temporary 45% Electricity Generator Levy will be applied on the extraordinary returns being made by electricity generators. There are a few points here. Firstly, is this the first recognition that the energy crisis will not wash out of the system until 2028? This represents between 65% and 75% tax on profits in total (after corporation tax at higher rates which is already standard on these companies) and is also effectively another transfer of Labour Party policy. The reasoning might be different – cash is needed from everywhere, rather than “deemed fairness” being the ultimate driver – but the outcome is the same.  


While taking these necessary steps, the government also recognises that businesses are facing significant inflationary pressures. The Autumn Statement sets out a package of targeted support to help with business rates costs worth £13.6 billion over the next 5 years. The business rates multipliers will be frozen in 2023-24, and upward transitional relief caps will provide support to ratepayers facing large bill increases following the revaluation. The relief for retail, hospitality and leisure sectors will be extended and increased, and there will be additional support provided for small businesses. This will be widely welcomed by those respective sectors, it is needless to say! Here at least inflation is being used to eat away at business rates which otherwise risk putting many tens of thousands of businesses in these sectors into administration and again, using a 5-year plan kicks the can down the road but recognises the length of time that will be needed to repair these sectors which took a huge kicking, as a whole, during Covid.


The government is taking a balanced approach between revenue raising and spending restraint, whilst protecting vital public services. The Autumn Statement confirms that total departmental spending will grow in real terms at 3.7% a year on average over the current Spending Review period. Within this, departments will identify savings to manage pressures from higher inflation, supported by an Efficiency and Savings Review. This is a GIGANTIC real terms increase in the circumstances (remember, real terms means AFTER inflation) – and a surprise for the markets overall, because larger cuts were widely expected. Bizarrely – this is inflationary, or more accurately, less disinflationary than expected – which has implications for interest rates – and indeed, the immediate impact was to send rates expectations upwards and 0.5% is the markets favoured prediction for the December Bank meeting. I still feel 0.25% is on the table here because of the feelings of 2 or 3 members of the committee – but 0.5% does look likely now for December.


To help get debt falling, for the years beyond the current Spending Review period, planned departmental resource spending will continue to grow, but slower than the economy, at 1% a year in real terms until 2027-28. Total departmental capital spending in 2024-25 will be maintained in cash terms until 2027-28, delivering £600 billion of investment over the next 5 years. This is another way of saying that there will be a real terms cut at those points, but those cuts are being saved until after the next election. What a “fluke” that is – one more punt of the can down the road, one more time. (Cynical I know – an alternative viewpoint might be that this is good politics).


This includes maintaining the government’s commitments to deliver major infrastructure projects. While delivering overall spending restraint, the government is prioritising further investment in the NHS and social care, and in schools. Supporting these two public services is the government’s priority for public spending. The Autumn Statement makes up to £8 billion of funding available for the NHS and adult social care in England in 2024-25. This includes £3.3 billion to respond to the significant pressures facing the NHS, enabling rapid action to improve emergency, elective and primary care performance, and introducing reforms to support the workforce and improve performance across the health system over the longer term. The NHS’s performance is closely tied to that of the adult social care system, so the government will also make available up to £4.7 billion in 2024-25 to put the adult social care system in England on a stronger financial footing and improve the quality of and access to care for many of the most vulnerable in our society. This includes £1 billion to directly support discharges from hospital into the community, to support the NHS. You will find few people who consider this to be bad news, and it is difficult not to support spending on both of these services which have been put under extra pressure by misguided austerity policies in the 2010s. 


The Autumn Statement announces a real-terms increase in per pupil funding from that committed at Spending Review 2021. The core schools budget in England will receive £2.3 billion of additional funding in each of 2023-24 and 2024-25, enabling schools to continue to invest in high quality teaching and to target additional support to the children who need it most. You tend to see this quite a lot and it makes such statements hard to interpret – a “real-terms increase” (no number given) and then the absolute funding increases (i.e. before inflation) to primarily “sound good” rather than actually use the percentage, as was used above, around 3.7% increase in spending in real terms, which is much more informative.


The government has taken unprecedented steps to help households deal with rising living costs and the energy crisis in 2022-23. The level of spending seen this year, if sustained over time, would add further upward pressures on inflation and interest rates and risk excessively burdening future generations with higher debt. This is a complex argument. Spending puts pressure on debt in a deficit and so that bit is difficult to argue with. However, by allowing energy prices to rise by a significant amount, another 20% next year, that contributes directly to inflation. More borrowing will mean higher borrowing rates so it depends which interest rates we are talking about, to an extent. In conclusion, there are upwards and downwards pressures, and it isn’t quite as clear cut as this.


The Autumn Statement sets out steps to taper the support next year and make it more targeted to those who most need it, while also raising more through levies on energy producers. The Energy Price Guarantee (EPG) will be maintained through the winter, limiting typical energy bills to £2,500 per year. From April 2023 the EPG will rise to £3,000. With prices forecast to remain elevated throughout next year, this equates to an average of £500 support for households in 2023-24. On top of this, to protect the most vulnerable, in 2023-24 an additional Cost of Living Payment of £900 will be provided to households on means-tested benefits, of £300 to pensioner households, and of £150 to individuals on disability benefits. This is a clever way of keeping the new, elevated prices (89% up year on year – yes, that’s not a typo) the same for the most vulnerable – so should be applauded overall as there is no better way to protect those who are vulnerable to early death thanks to energy poverty than this sort of direct action. Those who don’t quite qualify will be hurt by another 20% demand on their energy bills of course, but that’s the nature of the beast when means-testing.


The government will also raise benefits, including working age benefits and the State Pension, in line with inflation from April 2023, ensuring they increase by over 10%. This MASSIVE statement was the subject of much speculation, and is in a way a surprise compared to the character that Hunt particularly is normally portrayed to play. Credit where credit is due. “Over 10%” is a bit disingenuous when the number is 10.1%. 


Alongside direct support, the government is setting a national ambition to reduce energy consumption by 15% by 2030, delivered through public and private investment, and a range of cost-free and low-cost steps to reduce energy demand. This is some ask. There would have to be really meaningful moves in the energy used by households, and insulation, which is yet to get off the ground realistically despite it being a major topic over the past few years. The trend has been downwards over the past 30 years (mostly), and this is not impossible, but is ambitious for sure.


Economic growth is the only way to sustainably fund public services, raise living standards and level up the country. Self-evidently true.


The Autumn Statement sets out measures to boost growth and productivity by investing in people, infrastructure, and innovation. These include additional support to increase labour market participation; increasing public investment in infrastructure across this Parliament; delivering planned skills reforms; and supporting R&D by increasing public funding to £20 billion in 2024-25. The government will ensure that those sectors which have the most potential for growth – such as digital, green technology and life sciences – will be supported through measures to reduce unnecessary regulation and boost innovation and growth. This is not just lip service – these do represent some of our best chances but are unlikely to take us back over 2% growth as a country in the near future.


The Autumn Statement also announces the final Solvency II reforms, which will unlock tens of billions of pounds of investment across a range of sectors. By taking difficult decisions on tax and spending, the Autumn Statement sets out a clear and credible path to get debt falling and deliver the economic stability needed to support longterm prosperity. On balance, this is a reasonably fair comment and is a far, far better effort that the KamiKwasi efforts in late September 2022. Thank goodness for Jeremy Hunt (I will be surprised if I type that again!).


So, that concludes the macro part of today’s efforts – we can now get a bit more specific to work out a little more about how our own pockets will be contributing towards the black hole, some of which was left by the Truss administration (the “Moron premium” or “Moron tax” as traders have been calling it), some of which was inevitable as inflation spiralled away from the Government and the Central Bank.


The eagle-eyed and eared will have heard a reduction in the Capital Gains Tax thresholds in terms of allowances from £12,300 to £6,000 next year and £3,000 the year after. This is actually a fantastic result for most, in reality, and clever because it takes more tax from the smaller fish that pay it and so it raises more money. This is an issue of framing – if, instead, CGT went to income tax rates (a difficult move to argue against, in the backdrop of the current situation) the incidence would be far, far higher especially for the very wealthy, who, of course, still remain mostly protected. Good business, but bad result in isolation from UK PLC.


The same goes for the Dividend tax allowances. The same argument does not apply as does to CGT, because Dividend tax effectively works at the same rate as PAYE these days thanks to moves made by Osborne some years ago – but still, some allowance is better than none. The “old” £5,000 allowance was already down to £2,000 and now goes to £1,000 and then £500. It will soon be gone, no doubt.


Inheritance Tax is also frozen in line with other freezes – this is no surprise at all. Stamp Duty cuts made by Kwarteng, potentially one of the only sensible and decent policies under the Truss administration, will now “stay in place until March 2025” – once again kicked down the road until after the next election.


Overall – as so often, many of the worst fears were not realised. Rent caps or freezes (as they are currently disguised in Scotland, although the legislation says different) were avoided. Lower energy support takes more money out of the pocket of households, which affects rents. Landlords specifically escaped extra torture (remember everyone with income, and everyone with a limited company, landlords usually having both, got hit) as was speculated. Reasons to be cheerful?


Final thoughts though – the OBR, which the Treasury is obliged to use as its forecasting body, has a much less bearish view of the economy than the Bank of England’s model (a shorter recession, and unemployment at just under 5% on the upside, much more realistic in my view) sees inflation at 7.4% next year (this feels about right to me, with risks to the upside, not the downside) and sees it ebb away quickly in 2024 and 25 with more deflationary risks. I’m not there on this front just yet and at a simple level just DO NOT see it being extinguished that quickly – my idea of a figure for 2024 would be more like 4% than the 2% or so that the OBR are predicting. They see 8 quarters of deflation which is where models fall over, because if this was the case we would see significant monetary and fiscal policy action in order to avoid the damage of deflation for 2 years in a row – but this can is kicked down the road and doesn’t make the headlines while inflation is capturing everyone’s imagination. 


We’ve still got social unrest to deal with, and Shelter themselves are combating this this week, while lobbying for gigantic increases for housing benefits and rent freezes, they themselves have offered their staff a meagre 3%, well under even what the third sector/charity sector has been offering as a whole. You can’t help but appreciate the irony of this, whilst understanding that many charities are struggling with donations as charity begins at home, particularly in a cost of living crisis. As a backdrop however many charities are agreeing to pay the real minimum wage as, in reality, charity begins with the staff who accept lower remuneration than they would get in the private sector, often for in more challenging circumstances. The irony was not lost on me here. Until next week…..