Please find below our Investment Market Update as at 25th March 2022.
Blue Sky Investment Market Update
How well off do you feel?
An interesting question in the light of the comments made by the Office of Budget Responsibility (OBR), just as the Chancellor announced his Spring Budget this week.
The headlines screamed out: “UK to face the biggest fall in living standards since records began”.
Inflation and tax rises will likely cause living standards to fall by 2.2% in 2022-23, the greatest fall since records began in 1956. That’s some statement!
Do you personally feel this? Perhaps you do, but whilst costs are rising and investment markets are volatile, from what we are seeing through the lens of our clients, most have a sufficient buffer to cope with this microcosm of rising inflation and interest rates. Unless of course, you are doing significant building work at the moment! Blimey, the price of labour and raw materials has soared, haven’t they?
Those, who are likely to feel this more are new, young house buyers and the elderly. Those in work should be ok and with good budgeting, most should be able to cope with this short-term shock. However, the Chancellor warned that the OBR report had not accounted for the full impact of the Russian invasion of Ukraine and “we should be prepared for the economy and public finances to worsen, potentially significantly“.
Inflation outlook for the UK
The OBR said that it expects inflation to average 7.4% this year. The Bank of England (BoE) had previously warned that inflation could reach as high as 8%, but the OBR now sees inflation hitting a 40-year high of 8.7% in the fourth quarter of this year.
Some perspective is required. We have repeatedly stated that we expect inflation to fall in 2023 and 2024. The OBR believe that inflation will reduce to 4% in 2023 and just 1.5% in 2024. However, the OBR noted that there was significant uncertainty; “if energy prices remained at current levels beyond the middle of next year, the UK would face a larger and more persistent increase in inflation and a fall in real household incomes. If prices fall more quickly than currently expected, the reverse would be true“.
However, the Chancellor emphasised that unemployment was still forecast to be “lower in every year” for the next five years, as it currently sits at a pre-pandemic level of 3.9%. When we step back, things don’t look too bad do they. High employment and lower taxation coming down the tracks! Of course, the debate about whether we should pay higher taxes is for another time.
Much needed stimulus
The comments in the Spring Budget were partially designed to spur economic growth and close the productivity gap between other nations, especially due to the UK’s lower rates of innovation and capital investment. The Chancellor said the new reforms to research and development tax credits around business investment in the autumn, is meant to address these problems.
He, of course, spoke about his vision for a lower tax economy and announced some immediate changes. See a copy of his letter at the end of this communication.
Richard Carter, Head of Fixed Interest Research at Quilter Cheviot, said that “while the unemployment rate is expected to be unaffected by the slowing of economic growth, it does feel as if we are entering a stagflation period. It will be difficult for the economy to emerge from this without some additional stimulus, but with interest rates on the rise it is a tricky balancing act for the government and the Bank of England“.
In times like this, should we invest in gilts?
In last week’s communication, I highlighted that so-called safe haven assets such as gilts are no longer safe havens at all. Again, another good article in Investment Week recently crystallises these thoughts. It’s worth remembering that gilts used to play a significant part in our portfolios but don’t any longer.
For the past 14 years the Bank of England has been buying bonds – close to £1 trillion worth. But in the coming months that process is expected to be reversed.
The decision to raise interest rates to 0.75% brings us closer to the point when quantitative easing becomes quantitative tapering. The BoE has said it will seek to begin actively selling its gilt holdings once interest rates hit 1%. The BoE also said it would begin to reduce its stock of gilts by allowing them to mature. The first tranche of £27.9 billion matures this month, and by the end of 2023 just over £70 billion worth of gilts will have been removed from the balance sheet.
Quantitative tapering is on its way, if only slowly, and we have to consider the consequences.
The BoE owns around £875 billion of gilts – out of a total market worth of around £2.6 trillion. In other words, quantitative easing has consumed a third of the gilt market. Excluding inflation-linked bonds, which it does not buy, the BoE owns 51% of outstanding conventional gilts. The real concern is around long dated gilts, as its these gilts which have been supported by quantitative easing, and that support is about to be withdrawn.
It’s a different story with green gilts!
In the Spring statement it was announced that the UK is to raise a further £10 billion in green gilts. This will be issued by the UK government to finance projects that have clearly defined environmental benefits. The Debt Management Office (DMO) said that this new issuance was “subject to demand and market conditions, with the current expectation that this will be issued across both medium and long maturities“.
Last year, the government launched the UK’s Green Financing Programme, and has now raised £16.1 billion through the sale of green gilts so far. The first green gilt was issued in September, raising £10 billion, the largest inaugural green bond issuance by any country. A second issuance in October then raised £6.1 billion with gilts expiring in 2053, which the DMO said had the “longest maturity of any outstanding sovereign green bond to date“.
A snapshot of market activity this week
The markets have been fairly sanguine this week after the recent surge. In general, there has been a slight tick up in prices throughout the week.
The S&P 500 (US) rose yesterday by 1.43% which will feed into our portfolios tomorrow and the Dow Jones increased by 1.02%. The standout performance however has been the technology orientated Nasdaq, which posted an increase of 2.2% yesterday. Over the past five days this index has risen by 5.01%.
What lovely weather we’re having right now and, like the markets, all is calm for the time being. Make the most of it. Next week I’m venturing off to Rome and Florence and so young Gus (Andrew) will be writing our communication next week.
Have a lovely weekend,
Gary and the Blue Sky Investment Team
My vision for a lower tax economy
As part of Spring Statement 2022 I set out the government’s Tax Plan. This three-part plan to strengthen our economy covers the remainder of the Parliament. It will help families with the cost of living, it will support growth in the economy, and it will ensure the proceeds of growth are shared fairly.
Spring Statement 2022 enacts the first part of the plan, with tax cuts on incomes and energy to help families with the cost of living. Fuel duty on petrol and diesel has been cut by 5p per litre for the next year. From July, taxes for working people will fall as National Insurance thresholds rise – so people can earn £12,570 free of tax, saving the typical employee over £330 a year. This tax cut means the UK now has some of the most generous tax thresholds in the world. These tax cuts will provide meaningful support to tens of millions of people in the United Kingdom.
The second part of our Tax Plan is to boost growth and productivity. For decades, the UK has lagged international peers in investment in capital, people and ideas. Once the super-deduction ends in April 2023, we will cut taxes and enact long-term reforms to incentivise businesses to invest more in these three critical areas. We will work with industry over the remainder of 2022 and plan to announce our conclusions at the Budget later this year.
The final part of our Tax Plan has a simple goal – to let people keep more of what they earn. To that end, I’ve announced a cut in the basic rate of income tax in 2024 – this is a £5 billion tax cut for workers, savers and pensioners and will be the first cut to the basic rate in 16 years.
This Tax Plan represents the biggest net cut in personal taxes in over a quarter of a century. It is only possible because of the difficult decisions taken by the government in the last twelve months. Cutting taxes sustainably requires prioritisation and a commitment to fiscal discipline. These are the foundations of this plan and our future low tax economy.
Chancellor of the Exchequer
Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.