Gradually Then Suddenly, UK Budget Clarity Is Coming

Good news! UK GDP rose 0.1% m/m in August, beating expectations for no growth.^[i] Industrial production led the charge, busting expectations for a small decline with a 0.8% m/m jump.^[ii] Yet coverage dwelled on a drawback: consumer-facing services’ second-straight drop. That triggered another round of Budget leaks and rumors, epitomizing the uncertainty hanging over UK stocks. But clarity is less than two weeks away. We think markets should feel some relief at this, even if the Budget has some pain points.

Whenever economic data hit before an election or other political event, coverage tends to stress political angles. We saw that with US inflation Wednesday. Everyone interpreted it through a midterm lens. The UK’s lens is the Budget, which Chancellor of the Exchequer John Healey will unveil October 28. “Austerity” is the watchword, given rampant debt fears and higher government bond yields. Everyone is on high alert for tax hikes. Every rumored tweak, no matter the source, gets oodles of headlines. And every economic report gets the what does this mean for the Budget? treatment.

Simultaneously, lobby groups are in overdrive trying to convince Healey to refrain from taxing their constituents. Banks lobbied against bank windfall tax hikes. Investment groups lobbied against capital gains hikes. Grocers warn retail tax hikes will force them to raise consumer prices. Much of it amounts to public fearmongering—sharp warnings that Tax Hike X packs severe economic consequences while failing to raise revenue.

August monthly GDP collided with all of this. We wouldn’t read much into consumer-facing services’ slide. The -0.3% m/m drop looks iffy until you consider much of the drop came from restaurants, pubs and cafes, which got a big lift from England’s World Cup run in July.^[iii] The other culprit, a major drop in sports and recreation activities, isn’t exactly a broad bellwether. Meanwhile, retail activity rebounded from July’s slide, and non-consumer-facing services grew. Weakness wasn’t universal.

But everyone saw weak consumers, which probably informed Healey’s pledge Thursday to give consumers and businesses “breathing room” in the Budget. He declined to preview specific Budget items, but he reiterated the government’s focus on “the cost of business, not just the cost of living.”^[iv] The implication: Broad household and business tax hikes are off the table.

But it didn’t end there. In a separate interview, Healey called banks “an important part of our business. They’re a part of the jewel, if you like, in the British economic crown.”^[v] Some interpreted that as a retreat from raising bank taxes. But hours later, The Guardian reported Healey is indeed planning to hit banks in the Budget. Their sources didn’t name the exact policy but hinted reversing former Chancellor Jeremy Hunt’s cut to the bank profits surcharge is under consideration. That would lift it from 3% to 8%.^[vi] Now, these things aren’t necessarily mutually exclusive. You can value a sector’s economic contributions and tax them more, we guess. But the dueling headlines speak to the uncertainty.

Yet they also speak to creeping clarity. No one knows exactly what the Budget will entail, but the possibilities seem to be narrowing. Headlines have speculated over capital gains tax hikes for months, for instance. Think tanks and politicians spout proposals. Other think tanks publish doom-laden forecasts. But this week, the Treasury let slip that equalizing capital gains and income tax rates is off the table. That still leaves room for smaller hikes, but it removes the most painful move if true. Similarly, the Treasury’s briefing about bank tax hikes lets expectations for corporate taxes narrow.

Still, we have 13 more days of speculation about winners and losers. Stocks generally dislike this. People hate losing out to the taxman—see George Harrison with any questions. So when people broadly see a risk they lose in the next Budget, they wait for clarity. And probably are a bit moody while doing it. That can weigh on markets. Maybe with short-term volatility, maybe with underperformance. But markets also move on quickly. We have seen that with recent UK Budgets from both parties. Just knowing the rules brings relief. People can plan and get on with things. And often, whatever the government announces is watered down from earlier proposals and fears. Another relief.

So grit your teeth for a couple of potentially wild weeks in Britain’s markets. More rumors, more handwringing, maybe some market speedbumps. But then get ready for some bullish clarity.