Morning Markets – Public sector finances put Tories and Labour in a bind as election looms

by | May 22, 2024

Lindsay James, investment strategist at Quilter Investors comments on the latest financial market news, including UK public sector finances:

“After the IMF pointed to a £30bn hole in UK finances yesterday, figures out today show that at £20.5bn, net borrowing had come in £1.2bn ahead of the OBR forecast last month and £1.5bn higher than a year ago, as the spending increase of £3.1bn was almost double the growth in receipts of £1.6bn. Borrowing in the financial year to March 2024 was estimated to be £121.4bn, £6.4bn less than in the previous year but £7.3bn higher than forecasts by the OBR. With public sector net debt excluding public sector banks now provisionally estimated at 97.9% of GDP, 2.5 percentage points more than at the end of April 2023, finances are already stretched close to breaking point and at levels last seen in the 1960s, a time when the Labour Chancellor of the day was ultimately forced into a policy of tax increases and spending reductions.

This provides an intriguing backdrop for the general election that is expected to be held this year. We have seen the reaction from financial markets in recent years to unfunded tax cuts and spending plans, so manifestos from both Labour and the Conservatives will likely have to dial down the ambition and start being honest and upfront about what is possible from a tax and spending perspective. The spectre of the mini budget will loom large for some time to come, especially when debt is such a high percentage of GDP, and this will ultimately come to restrict whoever the public elect as its new government. 

That said, the economic tide will have changed by the time the election comes around and the mood may be brighter, as evidenced by the trend of inflation. Today’s inflation figure of 2.3%, a nose ahead of economists’ expectations and still above the Bank of England’s target, puts the UK on course this summer for its first rate cut in more than four years, keeping the UK on course this summer for its first rate cut in four years.  With energy costs such as gas and electricity causing the steep decline in the figure, Core CPI, which excludes volatile prices such as energy and food, still sits at an uncomfortably high 3.9%.  This is likely to add a note of caution to the Bank of England reaction, particularly given UK wage growth is running at 6% – well above the headline CPI rate. For now however, investors will cheer the fact the headline inflation has come back close to target once more. Historic data shows that in the absence of a recession, investment returns are strongest in the year after the first rate cut, so there will be lots of anticipation as the UK appears to turn the economic corner.

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