She was looking hunted. She knew she’d been rumbled. Understandably nervous on her first outing, Rachel Reeves had nevertheless given a confident if mechanically robotic presentation of the Budget. All the time she was relentlessly pressing the political point in tones that on occasions were more akin to those of a bossy headmistress about these being ‘my choices’ as to how to deliver economic stability as if handing down commandments on tablets of stone. After she sat down to the rapturous applause of the government benches, and the congratulations of Prime Minister Sir Keir Starmer, a strange thing happened. Her self-satisfaction began visibly to wilt. Responding for the Opposition and on his last public outing, former Chancellor and Prime Minister Rishi Sunak was on fire, completely in command of his brief and his facts, full of vim and vigour and with nothing else to lose. He lacerated the Labour Chancellor. If through a web of half-truths and re-writing history she was publicly going to heap all the economic woes of the world on the defeated Tories, he was having none of it; backing it with facts and a perfect recall of her pre-election promises he exposed her as mendacious, manipulative and mean. It was vicious stuff. As the cameras focused on her, her body language changed immediately; so did that of the new Prime Minister. Rather than smiling or laughing and finger-pointing back, Reeves gradually sank into the green bench and froze under the withering fire; the Prime Minister could not look and instead his eyes found something in the upper gallery that was suddenly very interesting, his mouth went down at the corners, his face a mask of uncertainty. However big its majority, this was a government unexpectedly under self-inflicted pressure on its showpiece battleground.

A Budget we are forced to remember but we would like to forget

Despite all the intense kite-flying, trailing and pre-announcements, for which Reeves was given a right royal rollicking from the Speaker for being in contempt of Parliament, the borrowing and tax raising amounts were every bit as bad as feared. That said, some of the more draconian measures that had clearly been socialised for inclusion were discarded: national insurance on unearned income; capital gains tax harmonised with the marginal rate of income tax; cutting the tax free lump sum on pensions; no mention of whether the mechanics of council tax will be reformed etc. It is entirely possible that these and others may be revived (in her own words ‘it would be irresponsible to rule out further tax rises’). On the other hand, the tax on employment was much worse than feared, so too the removal of the inheritance tax shield protecting the inheritance of family businesses and agricultural land and the abolition of the freedom to pass down the unused portion of pension pots to the next generation free of death duties. And delivered with pure spite, the confirmation that VAT will be charged and Business Rate relief abolished for private education. Still to be tested in the courts, Labour is determined to discriminate specifically against privately educated children, when student-paid university fees remain entirely free of VAT (incidentally, were we ever to join the EU again, Labour would have to repeal this legislation: in the EU it is illegal to tax any form of education however it is paid for).

OBR: an exercise in studied neutrality (but damning with faint praise by inference)

The Budget has won the unqualified endorsement of the International Monetary Fund (which says much more about the IMF than it does about the quality of the solutions to our problems). The Office for Budget Responsibility (OBR) neither publicly endorses the final Budget nor rejects it (the difficult conversations had already taken place before publication), but its reappraisal of the fiscal outlook reflecting the new landscape of taxation and expenditure allows the reader to draw their own conclusions. Beyond an initial boost to GDP¹ next year when the OBR predicts 2% growth compared with previous forecasts of 1.5% (pre-Budget) and 1.8% back at then-Chancellor Jeremy Hunt’s March 2024 Budget, the outlook for the rest of the parliament drifts back towards a mediocre 1.6%, sequentially losing ground compared with pre-Budget estimates. This is a double blow to Reeves: she wants to see sustained growth of 2.5%. Not only is there no multiplier effect either from increased operational public expenditure (as measured through productivity), or public capital investment (because it takes time both to implement and to allow a rate of return; there is no immediate satisfaction), but there is also a predicted drag effect from her measures compared with doing nothing. That is not to say there should be no investment; of course there must otherwise the country’s fixed assets–infrastructure: hospitals, roads, rail, jails, law courts, schools etc–will simply deteriorate to the point at which they fall to bits. What is questionable is the efficiency with which the investment programmes are executed. The track record of successive governments in this department is abysmal.

The deceit of employers’ National Insurance hikes

Back to that drag effect. Buried deep in the weeds of the detail of the Budget, Reeves and the Treasury seem to have lost sight of the corrosive cumulative and compounding effects of the government’s proposals. It is simply absurd to imagine that you can immediately saddle business with an additional annual £25bn cost of employing people through the increase in National Insurance, while you’re also adding even greater frictional employment costs estimated at another £5bn through Angela ‘Angry Ange’ Rayner’s changes to employment terms and rights, and the 6.7% increase in the minimum wage, all without any debilitating effect. As the OBR itself points out, companies cannot absorb all this cost without seriously compromising their margins and profits, their competitiveness and their ability to reinvest; the OBR estimates that 76% of the effect of the tax rise will be recouped through a combination of a fall in employees’ future real wages and reducing headcount (either by laying people off or not replacing them when they leave). To reinforce the point about the heft being placed entirely on the private sector, as we noted last week in the public sector the circularity of taxpayers’ money in which the state pays higher NIC as the employer and then rebates it from the Treasury creates zero net benefit to the economy.

 

The effect on the private sector is insidious but pernicious. Reeves, Starmer, and Bridget Phillipson (Education Secretary) touring the media studios ahead of the Budget and afterwards insisting that ‘working people will not see any difference in their pay slips’ might be telling the literal truth but there is an obvious underlying deceit that raising employers’ National Insurance has no effect on workers.

Hard choices? Not even scratching the surface

When it comes to operational spending funded from tax receipts, virtually all the Budget focus was on ‘how much’ with barely any reference to ‘how’. The tax burden (total tax income as a percentage of GDP) will rise to 38% from 37%, the highest since the war. Depressingly, Labour seems determined to prove Einstein’s Parable of Quantum Insanity: that doing the same thing over and over again somehow produces a different result.

The National Health Service is the major case in point. It is not under-funded; it is inefficiently structured and badly run. It already consumes 11% of GDP, 18% of government spending (over 20% including long-term care). It is not only the biggest employer in the UK and Europe, but also among the seven biggest employers in the world. Yet, despite all that, it has some of the worst health outcomes among its major peers and its key performance indicators are continually declining across virtually every metric. Demonstrably obeying the laws of diminishing returns, it devours every marginal bundle of cash that is tossed its way to zero net benefit. And then demands more. The enormous £22 billion injection of new cash (a large percentage of which is going on wages from the no-strings-attached pay awards made by Labour since it came to power) is a sticking plaster, but it is most certainly not the cure.

 

Health Secretary Wes Streeting promises a new ‘10 Year Plan’ to be revealed next year after a consultation process; it champions a shift from cure to prevention and a significant increase in the use of technology all directed at improving the patient experience and producing better health outcomes. It may work, it may not. But until the funding model and the basic modus operandi are challenged, the likelihood is little will change in terms of the cost of running the system and improving value for money. There is a plethora of other models around the world combining the public purse with health insurance schemes which could be used as blueprints to reinvent the UK’s healthcare wheel, combining the best of what we do in medical expertise with the best of how others deliver it efficiently and cost effectively. This is not just a fiscal choice; it is a political one. It is said that because it created it, only Labour can reform the NHS. The unanswered question is whether Labour is imprisoned by eight decades of slavish, dogmatic devotion to the founding principle that health must be free at the point of consumption. Or as its progenitor, does that confer the right on Labour to slay the dragon and demand a different way of doing things that are good for patients and the taxpayer (who, to point out the obvious, are the same people), and for the NHS itself?

 

While labouring (no pun intended) the point about the health service, the same reform arguments need to be made for other areas of government spending. With regard to benefits, particularly the 21.8% of 16-64 year-olds who are economically inactive (a figure boosted since Covid, particularly among the over 50s and in aggregate costing 10% of government spending) it should be about how to get them back into the workforce. There are three positive drivers: 1) to reduce the benefits bill; 2) to make them economically productive and self-supporting and 3) to boost the available labour force and expand the domestic economic capacity, the lack of which is currently deemed an impediment to growth (and the shortfall has to be met by importing foreign labour, putting constant pressure on housing and services). Defence received a welcome nominal increase in expenditure but the MoD’s reputation for waste and inefficiency in procurement and estate management is notorious and enduring, the net effect of which is literally a lesser bang for our buck. We could go on about many other departments.

A big way to produce very little

With tax revenues and borrowings raised in roughly equal measures of egregiousness over the next four years (the latter through breaking the fiscal rules through the spurious inclusion of questionable and difficult to value ‘assets’), the net effect on the country’s key fiscal ratios is discouraging. Instead of falling towards 90%, debt/GDP will remain at its current plateau of around 100% until almost the end of the decade (under the old system of measuring Public Sector Net Worth, the ratio would have been much higher). The deficit which is currently 4.6% was originally expected to fall to 1% by 2028/9 but will now be 2% — about which economists are sceptical in its optimism. Inflation is likely to push beyond the Bank of England target of 2% to around 2.6%, meaning borrowing costs are likely neither to reduce as quickly nor as far as markets had expected (which is why UK government bond yields have reacted by rising in sympathy). One of the few positives was Reeves conceding to three-year responsibility horizons rather than five.

Here is a ‘C’; and here is a ‘T’. Now please go away and spell CAT.

There is a solution and there is a logical sequence to it. We have rehearsed it on many occasions before in these columns, but let’s spin the record one more time: 1) fundamentally reform public services to reduce gross expenditure while improving outcomes and value for money both of which alleviate the burden on the state; 2) from that logically flows the reduction in tax rates which allows the private sector to garner investment to deliver consistently higher growth with greater efficiency generating a recovery in real wages and an improvement in national competitiveness (NB: DO NOT PERFORM 1 and 2 IN REVERSE! It is fiscally illiterate and induces instant nervous hysteria in bond markets); 3) we need to promote a more balanced economy in terms of how we drive our GDP growth: we have a myopic obsession with building houses as almost the be-all-and-end-all of inducing economic activity; further, currently only 30% of GDP is derived from exports while we ought to be aiming for 50% as seen in Germany; this requires risk-taking and innovative thinking about new, exciting products that other people want to buy; it allows the economy to develop its own momentum, no longer needing constant infusions of government cash to keep it going (which in turn completes the virtuous circle of creating and compounding national wealth and reduces the need to borrow); 4) it is difficult to be competitive with some of the highest industrial energy bills : they need to come down.

 

With clear strategic planning of a new economic framework and effective implementation and the right incentives in place, the debt/GDP ratio will fall doubly quickly: the debt numerator shrinks at the same time as the GDP denominator grows. It is the definition of a win/win. It would be not only restorative but transformational.

‘Cat’? Labour seems more intent on spelling ‘Catatonic’

It is abundantly clear that none of this is going to happen under Labour (it is still not obvious it will happen under the Tories regardless of who the new leader is).  For heaven’s sake, Labour’s mantra is ‘TAKE BACK CONTROL!’ which in its world means greater government intervention, a bigger state, and an explicit rejection of ‘failed’ free-market economics. When Reeves says ‘invest, invest, invest’ what she means is through government spending and, where partnering with the private sector, on the government’s terms. In any case, by adding in all those extra significant business costs, she is running the risk of two unhelpful outcomes: that UK employers devote greater attention to investing in foreign locations where governments do not take business for granted and treat it as a cash cow, and second, that overseas investors decide that the cost of doing business in the UK is too great, the returns are too low for the risk and there are more attractive opportunities elsewhere.

 

If the OBR is correct and we drift along in a catatonic torpor of mediocre growth, potentially that is the worst outcome. We continue to duck the really difficult problems with public services, yet we make just sufficient nominal economic progress that we think all is tolerably well. The reality is that we suffer relative decline and diminishing competitiveness.

 

The morning after the Budget, a pithy letter from a Jane Moth of Staffordshire appeared in the Daily Telegraph: “Sir, I had not realised that the government’s interest in assisted dying extended to the economy. Yours faithfully etc”. Perhaps Ms Moth is correct: maybe, like Greece a decade ago, or Argentina more recently, or indeed the UK itself in 1976, to avoid total self-inflicted extinction we need a near-death economic experience to expunge our lassitude and galvanise ourselves to those tantalising (but in this case with the right leadership and vision, achievable) sunlit uplands. As it is, we’re four-and-a-half years from being offered the choice about any possible alternative.

Market Perspective

UK government bond yields have been rising sharply in the past couple of weeks (prices move in the opposite direction of yields), first as investors digested the bewildering and belated potential doubling in the sum Reeves was looking to raise and how she would do it; the reaction with further rises since the Budget is a more considered calculation of the ramifications for inflation, the interest rate trajectory and longer-term investment risk now the markets are armed with the facts.

 

But this is not a UK-only reaction. The pattern has been repeated across the Eurozone and the US, even if for different reasons. As we discussed last week, investors are weighing up the changing risks and are adjusting to what they see.

 

Germany is a case in point: normally in times of stress, German bonds are seen as a safe haven to which to retreat; demand for German government bonds rises, prices go up and yields fall. Not today: in the month of October the 10-Year bond rose from 2.0% to 2.4%. Yet again, the German Traffic Light Coalition is struggling to produce a legal budget, caught three ways between a rock, a hard place and a cliff: a fiscal law which gives zero wiggle room (and unlike here, no facility to bend the rules and borrow like billy-o); the need to get the economy shifting when the courts dictate the fiscal parameters and the European Central Bank controls the monetary policy which has to suit 20 members and not just Germany; and trying to maintain political cohesion while German populism has a demonstrable momentum towards nationalism and xenophobia. The political death of this coalition has been predicted almost since its birth; the political will to remain in power has so far surpassed the almost constant internecine struggles dividing the three coalition parties. But once again speculation is rising about whether it will last the natural course of the electoral cycle. Add to this a further symptom of German industrial turmoil and lack of self-confidence; consider the enormity of what has happened this week with Volkswagen’s profits falling by two-thirds, having to perform major reconstructive surgery upon itself by closing plants (three) for the first time since the war, laying off tens of thousands of its workforce and slashing the pay of the remainder by 10%. That is a major industrial, economic and competitive blow, piling yet more pressure on Olaf Scholz and his deeply unpopular government.

 

In America, with less than a week to go before election day, markets are increasingly preoccupied about potential disruption and uncertainty in the event of a contested result and a delay in establishing the final lay of the political landscape across the Congressional estate.

 

There is a lot going on. No wonder bond markets are volatile!

 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions. 

¹GDP or gross domestic product, is a measure of the size and health of a country’s economy

Authors

The value of active minds – independent thinking

A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.

Fund specific risks

The NURS Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. The Jupiter Merlin Conservative Portfolio can invest more than 35% of its value in securities issued or guaranteed by an EEA state. The Jupiter Merlin Income, Jupiter Merlin Balanced and Jupiter Merlin Conservative Portfolios’ expenses are charged to capital, which can reduce the potential for capital growth.

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