JP’s Journal: Nailing colours to the mast

Last week’s UK focus was on the Budget. The detail and interpretation were covered by Melanie Baker while Ben Nicholl outlined the gilt market verdict.

However, from my perspective the Budget does not provide a narrative for growth because overall, while infrastructure is an important requirement it is not the main driver of growth. Similarly, better NHS services may help address long-term sickness but this is not a silver bullet. What is missing is recognition of the pivotal position of the entrepreneur. This is not the small number of tech or finance whizzkids, but the thousands of small business owners, the true engine of growth over centuries. Despite some cosmetic concessions, this Budget and additional changes will place a high burden on them.

Institutions play a vital part in economic success. As outlined in Why Nations Fail, the authors of which recently received the 2024 Nobel Prize in Economics,  the economic success or failure of countries reflect the political and subsequent economic models permitted by the former. In essence, a society that respects property rights, which fosters scientific and technological progress, which is centralised enough for the rule of law to be maintained yet pluralistic (where citizens having a stake in the outcome) is well placed to succeed. There may be an element of looking back at what has worked, Britain in the 18th and 19th centuries and the US more recently, but it makes sense. In such an environment the entrepreneur can succeed and competition kills off the inefficient or complacent.

Perhaps, as the role of government grows and with fewer legislators having a small business background, there is a tendency to view things from the perspective of the giant (both labour and capital) and less from that of the challenger. This benefits the incumbents, who are better resourced to deal with greater regulation and bureaucracy. But it makes economies less efficient. As an aside, a statistic caught my eye last week. In answer to a Freedom of Information Request it was revealed that there are 63,700 civil servants in the Ministry of Defence (MoD) compared with the combined armed forces (Army, Navy, and RAF) of around 130,000. So, there is approximately one civil servant at the MoD for every two service personnel. Is this an example of administrative growth to aid efficiency or bureaucratic creep? Does it have wider resonance?

Another story that drew my attention was the criticism of the Office for Budget Responsibility (OBR), by the previous Chancellor of the Exchequer. Actually, the arguments of whether the OBR has acted in a party political manner in the timing of its release is academic. The point is that the independence of the institution has been called into question. If it loses a reputation for impartiality, in the eyes of  participants, it is likely to have negative long-term consequences. This is important from a market perspective as the OBR – post the Truss premiership – has been elevated to heroic status. Like Caesar’s wife, the OBR must be above suspicion. The heat has been taken out of the issue because the OBR has knocked back on some of the Chancellor’s assumptions regarding the amount of tax raised through the National Insurance (NI) increase. Not £25bn but probably nearer £16bn in their estimation and likely to be £10bn when compensating payments are made to public sector employers. The impact on GP surgeries and care homes will also need to be addressed  – as it stands, we are heading for a crisis in social care.

Drowned out by Budget speculation was a court case that has caused consternation in the motor finance industry – and one with wider implications for all sorts of lending. Without going into the legal quagmire, the result is that companies are withdrawing from motor finance. To date there has been no quantification of the potential economic impact but it must have an big and immediate impact on car sales. Certainly, one to watch.

The Bank of England will note the impact of the budget and these other economic developments when they consider interest rate setting this week. It looks likely that we will get another 25bps cut, taking base rate to 4.75%. However, bond investors have scaled back their expectations of the extent of monetary policy easing, with UK rates now priced to be around 4% in 12 months’ time. UK 10-year yields rose by 20bps, ending the week  just under 4.5%. Whilst there was no panic in markets, the reaction has been marked, with UK 10-year rates now 2% higher than German government debt. More broadly, higher government yields were a theme last week, with US 10-year yields closing around 4.4%, up 10bps. On the election front, the most recent polls are encouraging for Vice President Harris, especially her lead in Iowa. Meanwhile, credit continued  to outperform government debt, with high yield again leading the way.

It looks highly likely that we will get another 25bps cut, taking base rate to 4.75%

Let’s end back on the UK Budget. The fact that the IMF has welcomed this Budget is not a surprise. Another institution staffed by very clever people but have they practical business knowledge? As someone who studied economics at university, there often appears to  be little correlation between the subject and the real world. In many ways this Budget might be the mirror image of Lizz Truss’ offering. It is the left of centre solution to raising growth – but one with much more institutional backing. The Chancellor has nailed her colours to the mast: more investment spending will deliver higher growth, setting off virtuous feedback. Let’s hope she is right.

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