Investment Management Blog - Montague Capital

Let’s talk budget…….

Having flopped dismally in his pre-budget statement last Autumn, Alastair Darling’s first full-dress budget on Wednesday once again singularly failed to impress the examiners. To judge by Darling’s style of delivery, which made Gordon Brown’s witty and humorous approach when he was Chancellor look like Ben Elton at the end of a particularly frantic set, Darling hadn’t impressed himself either. Claims for economic growth and government debt simply don’t ring true. The Treasury forecasters look behind the curve in predicting growth of 2% this year, rising to 2.25% in 2009, while the PSBR rises no higher than £43bn in FY08. However, the Treasury was also quick to insert its get-out clause against the failure of these predictions such that failure won’t be HMG’s fault. The credit crunch “could detract from the average rate of output growth over the medium term”. The wider uncertainty about what happens next that has ossified the banking system could have been eased had Darling tried for a more realistic approach, but then he is a politician. More than that, he has very limited room for manoeuvre.

So what have we got?

What we end up with is a budget that is mildly contractionary just at a time when that is what is least required. Darling is a gnat’s knacker off breaking the ceiling on the PSBR imposed (quite correctly, in the interests of financial discipline) by Gordon Brown. Other than the pressing need for extra funds for the MoD to sustain the UK’s presence in Afghanistan and for the alleviation of child poverty, there really wasn’t a snowball’s chance of a fiscal stimulus to try to offset the effects of the credit crunch and the impotence of monetary policy (the Budget raised the 2008 inflation forecast). Nor could Darling tighten the tax net dramatically to try to rein in the PSBR without triggering the very recession he is so desperate to avoid. Nevertheless what he did do on the tax front leaves almost all of us potentially worse off. A reduction in the 22% income tax band to 20% is wiped out by the elimination of the 10% band (except for savings account) and the interim step towards raising the national insurance cap to the starting point of the 40% income tax band. Alcohol of all kinds is seeing duty increases way above inflation which will continue to rise at 2% above inflation for the next five years. A showroom levy on new cars and the introduction of new road fund license bands for gas guzzlers could take another £1.2bn out of individuals’ pockets, although a slower economy will almost certainly involve slower new car sales.

And here’s a potential problem…………..

With banks not lending, the UK housing market will no longer be able to perform its role as a money printing machine to drive growth. No more equity withdrawals to fund consumption we wouldn’t otherwise be able to afford. No more lavish makeovers when people move house to keep the building and DIY trades happy. No more CGT and stamp duty receipts to swell HMG’s coffers. And as all this saps the momentum for economic growth, the prospects for consumption and employment at the margin will deteriorate. But in spite of this Darling has added to the squeeze on household consumption from rapidly rising input prices at one end by raising indirect taxes at the other, so cutting the effective buying power of household disposable income. If the Treasury has been slow in coming to terms with reality in its economic growth forecast, the markets have been slow too in what it will mean for corporate results. We’re not yet looking at a doomsday scenario, but suggestions that we’re due to be back off to the races tomorrow look less persuasive than they weren’t before. UK plc can’t do more with less.

What’s going on in the US?

Across The Pond denial is in full swing. The Fed is going to do “whatever it takes” to avoid a 1990s-style Japanese recession. Quite. Let’s just remind ourselves that that recession was caused by a credit crunch after Japanese banks had been lending without any sense of risk since the Plaza Accord of 1985 (designed, but failing, to address the US trade deficit) only to find that they didn’t know (for a very long time) how little that lending was then worth. Sound familiar? The Japanese solution was to cut interest rates to zero and flood the system with cash, but no-one was prepared to lend or borrow. Does that sound familiar? Fifteen or so years of recession has only been ended (sort of) by saddling Japan with an eye-popping level of government debt in excess of GNP as it threw money at the wrong sort of fiscal stimulus, that is, serving special interest groups with big political clout. Does that sound familiar? But this won’t happen in the US, because the Fed won’t allow it to. That’s convincing.