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Repo rates are expressed relative to SONIA, and the chart below displays the average repo rates that we have achieved over the past four quarters for three, six, nine and 12-month repos, shown as a spread to average SONIA levels at the time. The volatility and market uncertainty that resulted from the mini-Budget also weighed upon funding markets, particularly for shorter dated trades as can be seen from the achieved spreads below. Note that during the fourth quarter of 2022 no repos were traded with a 12m tenor so the chart reflects the previous quarter’s value.
Source: Columbia Threadneedle Investments and Bloomberg as at 27/06/2024
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Themes
The secondary impact of the mini-Budget crisis centred around collateral and the velocity of movement; rather than a lack of balance sheet for repo funding (a la March 2020). Yet, the difficulties around collateral substitutions and settlements did in many cases prompt a review by individual banks’ credit officers, resulting in a temporary reduction or hiatus in repo balance sheet provision in some cases. Once these reviews were completed balance sheet availability opened up again – some with the addition of haircuts to provide additional protection to the bank. Of course, the momentous lack of certainty in the future path of interest rates also impacted the typical repo spread to SONIA as trading a fixed rate forced the banks to take a conservative view on where yields could reach.
Regions
After inheriting a dire fiscal position how will Labour deliver economic growth? We take a closer look at their options and plans.
The strength of the UK economy is underappreciated, and in that sense Labour is lucky. However, the fiscal position that they inherit is dire, with both debt and taxes around the highest levels for decades. Without the option to ‘tax and spend’, Labour has preferred to focus on boosting economic growth to deliver on their objectives. Labour’s plans are ambitious and radical, and will be challenging to deliver. In the meantime, to fund these new projects and cover any budget gaps, Labour has a list of new taxes. Having foresworn unpopular increases to basic income tax, taxes on capital are the focus and we review a list of possible and probable targets in addition to those areas already announced.
Forecasts for UK growth rise
Source: Columbia Threadneedle Investments and Bloomberg as at 05/07/2024
Growth
The UK recovery from last year’s ‘technical recession’ is on the back of a virtuous circle of falling inflation and easing wage growth as real incomes rise. This should encourage UK consumers to reduce their current high level of precautionary savings, providing an additional leg to growth. Interest rates should also start falling this year, with the first cut likely in September if wage inflation continues to trend down. A fly in the ointment is a recent rise in gas prices that could lead to higher energy bills this winter.
We see clear signs of a UK housing market recovery. Even modest house price increases are sufficient to stimulate transactions and support economic activity, as well as boosting consumer confidence.
It is not just the outlook for UK that is improving, with support coming from the global economy. The recovery in Germany has boosted European growth. By contrast, it is the US economy that is more likely to face headwinds, as consumers rebuild savings, but this is likely to slow rather than halt growth.
US saving less, UK saving more
Source: Columbia Threadneedle Investments and Bloomberg as at 05/07/2024. Horizontal lines show pre-covid averages.
Dire fiscal position
After highlighting the underappreciated strength of the UK economy, it is necessary to provide some balance by looking at the dire budget position. The cost of dealing with the Global Financial Crisis and Covid have ratcheted up the level of debt, so it is now almost equal to a whole year’s production.
With interest rates at higher levels, and no expectation that forthcoming cuts will bring interest rates or bond yields back to the levels of the previous decade, the debt costs are an additional burden on the budget. There are, of course, no shortage of other areas that need additional resources, including the government’s new projects, such as a sovereign wealth fund and an energy fund.
The answer from the new Chancellor, Rachel Reeves, is not to raise significant extra taxes, which are already at record highs, but an ambitious plan to boost growth and improve productivity.
Government debt rises to almost 100% of GDP
Source: Columbia Threadneedle Investments and Office for National Statistics as at 27/06/2024
Little room for tax increases
With the level of taxes at historic highs, there is little room for new taxes that will not have counter-productive impact on growth. In any event, the new Labour government does not favour a ‘tax and spend’ policy and specifically ruled out changes to Income Tax and National Insurance.
While the Labour government is keen to fund its new projects and provide additional resources for underfunded government services, it is constrained by a desire to ensure that spending does not come at the expense of economic growth. As a consequence, many new initiatives will be dependent on funding from private capital.
Taxes that Labour said that it would increase include VAT on private schools, tighter rules on overseas residents, extending the energy levy and income tax on private-equity carried interest.
Our best guess of areas that Labour will look to tax to fill inevitable shortfalls in government revenues and additional expenditures in the 2025 budget includes the following.
- Probable: Excise duties, though road fuel is more likely than alcohol; Capital Gains Tax.
- Possible: Inheritance Tax (IHT); ISAs; Council Tax additional bands.
…but taxes have also gone up
UK government total receipts, % GDP
Source: Columbia Threadneedle Investments and Office for National Statistics as at 27/06/2024
Labour’s ambitious plans to boost productivity
UK productivity growth has lagged previous levels and also its peers in the years since the Global Financial Crisis. This lack of productivity gains has had a significant cumulative impact on the size of the UK economy.
The new Labour government has an ambitious plan designed to reverse the previous trend and boost growth. That is clearly a laudable objective, but the gains are incremental and will accrue over many years. On the other hand, there will considerable upfront capital costs, unpopular political decisions to be made and, even if things go well, some projects will fail – any of which could derail the whole plan before any gains are visible.
Housing will be the first sector of the economy to see Labour’s ambitious plans for increased growth and greater productivity in action. While it is obviously a sector ripe for improvement, there will still be considerable political costs as ministers override local planning objections, build on the green-belt and navigate the details of making industrial policy.
Public sector productivity growth non-existent
Source: Columbia Threadneedle Investments and Bloomberg as at 27/06/2024. Productivity is defined as output per hour of labour input
Summary
A positive economic background is a tailwind for the new Labour government, but the dire fiscal position is a major headwind.
Taxes will inevitably have to rise, but will target capital to spread the burden.
Even if successful, the major results of Labour’s ambitious plans to boost growth will take years to come through. However, housing is set to be the exception and therefore a test case.
