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The Macro Brief – The UK’s narrow margins
22 Plays1 year ago
Simon Wells, Chief European Economist, assesses the state of the UK’s public finances following this week’s highly anticipated budget. Disclaimer: https://www.research.hsbc.com/R/61/tzBdGWN. Stay connected and access free to view reports and videos from HSBC Global Research follow us on LinkedIn https://www.linkedin.com/feed/hashtag/hsbcresearch/ or click here: https://www.gbm.hsbc.com/insights/global-research.
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Transcript
Introduction and Podcast Details
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Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
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And now onto today's show.
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This podcast was recorded for publication on the 7th of March 2024 by HSPC Global Research.
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All the disclosures and disclaimers associated with it must be viewed on the link attached to your media player.
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And don't forget that you can follow this weekly podcast on Apple and Spotify, or wherever you get your podcasts.
Host Introduction: P.S. Butler
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Just search for The Macro Brief.
Analyzing Chancellor Jeremy Hunt's Budget
00:00:38
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Hello, I'm P.S.
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Butler and welcome to the Macrobrief.
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Now, here in the UK, Chancellor Jeremy Hunt announced his much anticipated budget this week.
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Why is it so important?
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Well, it's possibly the last before a general election.
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But against a backdrop of stagnant growth, was the Chancellor able to pull a rabbit out of his hat?
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Let's get the key takeaways from Simon Wells, Chief European Economist.
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Simon, welcome.
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Thank you.
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Simon, by the time our listeners are hearing this podcast, it will be Friday.
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So there'll have been lots of the big headlines on the budget.
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And I thought we'd take a look at it from a slightly different angle.
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One thing that isn't always appreciated is the role of the Office of Budget Responsibility plays in the budget.
00:01:19
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Can you remind us what that is and why you ignore it at your peril?
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Well, the Office for Budget Responsibility is the UK's fiscal watchdog and it's supposedly independent from the UK's finance ministry to provide a set of independent forecasts on which the government of the day can set its fiscal policy.
OBR's Influence and Fiscal Policy Impact
00:01:38
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So it provides a very important input and of course it does mean its implications are quite political.
00:01:47
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And on this occasion, unlike in the autumn statement late last year, it didn't really provide much by way of changes to the forecast and therefore it didn't provide a lot of additional money for the Chancellor to spend just on the back of its changing views on the outlook.
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What that really meant was that any tax cuts that were granted had to be funded.
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That's right.
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If the chancellor was going to hit its fiscal targets, which is what the OBR is judging him on, he needed to fund.
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And so that's what he did.
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The centrepiece of the budget was the two pence cut off national insurance, which is a form of income tax in the UK.
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And part of that had to be funded through a variety of measures, but it didn't fully fund it.
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So the Chancellor has to borrow more.
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And that means he is hitting the fiscal targets by a narrow margin.
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In fact, the OBR concluded there was only a 54% chance that he would hit those targets based on its forecast.
Tax Cuts and Financial Implications
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So it's a very thin margin.
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Nevertheless, overall, for household finances, this looks, on the face of it, a decent April.
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And is that why the odds of a May election may have tightened slightly?
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It's possible.
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This was clearly a budget aimed at cutting taxes and cutting taxes and promoting work.
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And in some sense, it did that.
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But we have to set this in the context of what is the so-called fiscal drag.
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And that is the effect of inflation when you freeze personal tax allowances.
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So more people are dragged into higher rates of paying tax, more people are dragged into paying tax full stop by the effects of inflation.
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end of the OBR's forecast, that fiscal drag is about £40 billion.
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And the tax cuts announced in the budget and last year's autumn statement combined only amount to about £21 billion.
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So we're really only offsetting half of the revenue raised from that fiscal drag.
00:03:51
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What were the policies we didn't see in the budget?
00:03:54
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Well, as I say, the centrepiece was the National Insurance Cut, but what he didn't do was cut two pence off the rate of income tax, the basic rate of income tax, which is more expensive.
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And the reason it's more expensive is because
Budget Gaps: Income Tax and Housing Policies
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it hits people who earn income other than through work.
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predominantly pensioners, of course.
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So there was not that much in there for pensioners who would have benefited from an income tax cut, but not necessarily the national insurance cut.
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And there wasn't that much in there for the housing market either.
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No major changes to stamp duty or changes to the mortgage market, which were things that had been speculated about in the press ahead of it.
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So those, I think, were the things that might have happened and didn't.
Government Spending Constraints and Tax Burdens
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So despite the Chancellor previously saying that
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the tax system when it comes to income tax was was quote-unquote unfair there wasn't any kind of radical reform.
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That's true for one fleeting moment having criticized the system it looked like he might go for radical reform but in the end he just went for the two pence cut and so is basically shrinking a system that he thinks is suboptimal.
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Coming back to this room for fiscal maneuver it is as you said very tight and clearly that requires cuts in government spending.
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That's right.
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Already, Jeremy Hunt, as a chancellor, has hit the fiscal targets with some of the narrowest margins since the OBR came into existence.
Future Government Challenges and Fiscal Margins
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But even that requires significant restraint in public spending over the coming years.
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Now, the actual breakdown of day-to-day public spending is only specified for the next couple of years.
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And beyond that, the Chancellor is committed to an overall rise in spending of 1% in real terms per year.
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So after the effects of inflation.
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But if you think about it, Piers, if you're going to have that 1% envelope and you're going to have certain ring-fenced areas of policy, let's say health and education, then you're going to need some big real-terms cuts in other areas of day-to-day departmental spending.
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That will be very, very difficult to push through.
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And so even though the tax burden is rising as a proportion of UK national income to levels not seen really since the end of the Second World War, there's still going to be an enormous amount of pressure on public spending and services.
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And to compound that,
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As you say in your report, that is based on what we think are relatively optimistic forecasts by the OBR.
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You mentioned this point of fiscal fictions.
00:06:23
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Well, that's right.
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And that relates to that 1% real-term spending envelope.
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I mean, can it really be done?
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Whoever wins the next election is going to face an enormous challenge to do
Budget's Political Implications and Opposition Challenges
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that.
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So that's why we've sort of termed it a fiscal fiction.
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Of course, it's not impossible, but it is going to be difficult.
00:06:41
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And you mentioned whoever wins the next election.
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I mean, if you're the Labour Party, is this budget a tricky one to respond to?
00:06:48
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And actually, they still have a lot of head scratching in terms of what they're going to do with the economy if they win the elections.
00:06:53
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Absolutely.
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And in fact, our preview to this budget was called by hook or by crook.
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And of course, if the chancellor wanted to cut taxes now, he could just claim he was going to cut spending even more in the future and still get things to add up.
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And that creates a much greater problem for the next government.
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If it's the chancellor, maybe he'd be quite happy to have that problem, given the current opinion polls.
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But if it's the opposition Labour Party, then they have to work out how they're going to deal with it.
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So yes, it is a very difficult one for them to respond to.
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Would they object to the tax cuts and risk an electoral backlash?
00:07:29
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Or do they go along with them and work out how to fund it through the fullness of time?
00:07:34
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We mentioned May election timing, but the odds still favour an election in the second half.
00:07:40
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Does that give the Chancellor a final opportunity for a tax giveaway?
00:07:43
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It is possible.
00:07:44
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There could be an autumn statement, a final fiscal event before the election, but really it would be very, very close to the election.
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There wouldn't be enough time for households to digest fully any changes to their finances.
00:07:58
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So I think to all practical and purposes, this was a last chance saloon.
00:08:03
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So now that the budget is out of the way, I guess the attention turns to the BOE, Bank of England.
00:08:09
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Where are we in terms of expectations of rate cuts from them?
00:08:13
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We're pretty much in line with the market now, I'm pleased to say, because at the start of the year we certainly weren't.
00:08:19
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And in the UK as well as elsewhere, those rate cuts have been pushed out a little bit.
00:08:25
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We are and have been expecting the first Bank of England rate cut until August.
Bank of England Rate Cuts and Inflation
00:08:31
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There are risks, you could say, in both directions.
00:08:34
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In the near term, we see inflation falling pretty rapidly as a result of base effects and energy prices.
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So inflation could be 1.2% in a matter of months in headline terms.
00:08:46
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Of course, core and underlying inflation is higher.
00:08:50
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And that headline rate will bounce back up again towards the end of the year as those base effects of energy drop out.
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So the battle against inflation isn't won.
00:09:00
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But when we're looking at those sub-target prints, the pressure is going to be on the Bank of England to cut.
00:09:05
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I think they're worried about underlying inflation.
00:09:08
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They're worried about service sector inflation in particular and wage growth.
00:09:11
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So they will wait.
00:09:13
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August seems most likely.
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But things can change.
00:09:17
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On that note, Simon, thank you very much for joining us today.
00:09:19
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Thank you.
00:09:23
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Let's finish with some key highlights from the global research team.
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This week, the top policymakers in China gathered for the annual National People's Congress.
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Among the key takeaways were a GDP growth target of around 5% this year.
00:09:36
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So can this be achieved?
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Our China economics team thinks so, with fiscal support that is punchier than the headlines suggest and policies to promote consumption.
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For details on this, take a listen at our sister podcast, Under the Banyan Tree, which this week features analysis from our chief economist, Jing Liu.
00:09:53
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Meanwhile, in the currency markets, it's been a tricky time for emerging market FX.
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Paul Mackle, global head of FX Research, says EM currencies will likely remain caught between two dominant forces.
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the U.S. Federal Reserve, and China.
China's Economic Outlook and Fiscal Policy
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Additionally, Paul thinks there will be increasing scrutiny of domestic policy choices and how they could impact their respective currencies.
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All these factors mean that we remain cautious on the outlook for EMFX.
00:10:19
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And a reminder that the first ever HSBC Global Investment Summit takes place in Hong Kong between the 8th and the 10th of April.
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More than 2,000 delegates will come together to hear insights into global trends from a world-class cast of experts, political leaders, and decision makers.
00:10:34
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For more details or indeed more information on anything that we've talked about on today's podcast, please email askresearch at hsbc.com.
00:10:46
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So that's it for this week.
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We hope you found the podcast useful.
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Please join us again next week for another edition of The Macrobrief.
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Thank you for joining us at HSBC Global Viewpoint.
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We hope you enjoyed the discussion.
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