“In our initial post-referendum economic update, we downgraded our forecast for UK economic growth. We expected a mild recession but were aware of potential downside risks in an environment of heightened uncertainty. Since then, our concerns have faded somewhat, as domestic political uncertainty has diminished with the quick appointment of a new Prime Minister and a measured approach to EU relations.
“The next key focus for us is what the government will do in terms of the budget. Like most commentators, we assumed that the government would allow ‘automatic stabilisers’ to work into a period of slower growth – for example allowing government spending to increase as unemployment benefits rise and tax revenues decline. But with the new Chancellor Philip Hammond saying that the UK can “reset” budget policy if necessary, and the government abandoning their previous objective of balancing the budget by 2020, it looks like a significant government tax cut or spending stimulus is on the cards in the upcoming Autumn Statement. This has led us to revise our UK growth outlook, with better-than-expected outcomes having now become more likely.
What options does the chancellor have?
• A VAT cut – this is a real possibility; it would be a quick and easy measure to implement, and could give a short-term boost to the consumer.
• A corporation tax cut – George Osborne talked about cutting corporation tax to 15%, but it is already set to fall from the current 20% to 17% by 2020, so this would only be a small additional stimulus.
• Other tax cuts – A stamp duty holiday or cuts for first-time buyers are also possible, although politically this could be difficult if it is seen to be helping higher earners.
• Get busy building – Additional government investment is likely to be more powerful than tax cuts. Typically the economy gets a greater boost per pound from direct spending by the government than from tax cuts. Additional investment could include infrastructure projects, research and development programmes, and increased housing construction. This would be better for the UK from a longer-term perspective, as it increases the country’s productive capacity.
What have we done in our portfolios?
“We believe the clearest implication of increased government spending (or tax cuts) for markets could be for the mid-cap sector in UK equities, especially stocks that benefit from infrastructure spending like contractors and homebuilders. The mid-cap FTSE 250 equity index sharply underperformed the large-cap FTSE 100 following Brexit, and has only partially recovered this relative underperformance. The FTSE 250 index is more exposed to what goes on at the grass roots of the UK economy, rather than the more international FTSE 100 index, so should benefit from any increase in government spending. With this in mind, we have recently increased our exposure to the FTSE 250 and a basket of equities that benefit from increased infrastructure spending.”
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