The UK Emergency Budget - Fisher Capital Management Report Part 1

Fisher Capital Management Report  - The UK has had an emergency budget and it could have been much

worse. The heavy lifting is being done by a rise in VAT bringing in

£13 billion. On the spending side the cuts are achieved by freezing

public sector pay, indexing state benefits to the CPI rather than the

faster-rising RPI and freezing child benefits. State pensions will be

indexed to the higher of wages or the CPI but the pension age will

be raised to 66 fairly soon.

The disappointment for the UK is on the tax side where compromises

with the worst aspects of the Lib Dems are apparent. CGT goes up

to 28% for top earners … a mistake.

The UK Emergency Budget - Fisher Capital Management Report: The 50% top tax rate and associated rise in the top marginal rate

on pensions have been left alone. There is a Bank Levy bringing in

£2 billion … defensible, just, at this level but it needs remembering

that taxpayers generally make money out of bailouts because they

get assets at knock-down prices and are able to hold them until

times are better. Then there are cuts in corporation taxes on both

large and big firms, which is to be welcomed.

But there is no clear logic here; no sense that the tax system is to

be remoulded, to give incentives for entrepreneurs, inward investors

to the UK and indeed home investors.

The main question that most people will be asking is whether the

fiscal arithmetic will come off and the deficit come down as planned

to 1.1% of GDP by 2015/16. The answer depends entirely now on

growth. Contrary to most people’s comments, cutting spending as

planned is not really that difficult.

The UK Emergency Budget - Fisher Capital Management Report: Much of it will involve simply freezing programmes in real terms

and also cutting pay in real terms, which the announced freeze on

pay will do. Probably some programmes can actually be cut without

much trouble given the considerable decline in public sector

productivity in the last decade … in other words value for money

in the public sector has never been worse.

The main issue is whether UK GDP will grow as forecast, at 2–3%

in the next few years. If it does, then revenues will recover

substantially.

Already the PSBR figures have come in some £10 billion below the

original projections and that seems to be because the original growth

figures for 2010 were too low.

There are good reasons for thinking growth of this order will occur.

The world economy is recovering rapidly, led by the East — China,

India and East Asia. These countries are achieving extremely rapid

rates of productivity growth by moving people out of lowproductivity

agriculture mainly into high-productivity

manufacturing. Hence their fast growth.

The problem for the West is that these countries also pre-empt

available supplies of raw materials such as oil. So if the West grows

any faster than its present moderate recovery, it would trigger

renewed surges in raw material prices, which in turn would reduce

Western productivity growth (factories are less profitable as those

prices rise).

So there is a built-in drag on western growth. But nevertheless

growth of the 2–3% order is in line with productivity growth at

current raw material prices.

One concern for the UK is whether the spending cuts and tax rises

themselves will derail the recovery. This is something that Labour

is emphasising.

However, the programme is spread out over five years and this

should be gradual enough to be absorbed with monetary policy

remaining supportive.

Fisher Capital Management News: Equity Markets

Equity Markets: All the major equity markets, and most of the emerging markets, Are stable over the past month. There had been expectations that the Fed might introduce further quantitative easing measures at its recent OMC meeting, and this provided some support for the markets in the early part of the month; but it made only very modest.

Government Bond Markets: The major government bond markets have made further significant gains over the past month, despite the funding pressures resulting form huge fiscal deficits, and the renewed concerns about debt defaults.

Short-term interest rates have remained low, and monetary policy has been supportive; but it has been the enhanced “safe haven” status of these markets that has provided most of the momentum, as investors have sought “shelter from the current storm”. However the moves have surprised most commentators, and this has led to warnings about “bond bubbles” that will not be sustained.

Financial Markets: Sentiment in the financial markets has deteriorated. Signs of slowdown in the Chinese economy, have produced a much more cautious view of prospects for the rest of this year and in 2011; and there have been renewed fears about banking problems in Europe, and the likelihood of sovereign debt defaults. There have also been further indications of the conflicting views of central banks about the most appropriate response to the current problems.

Currency Markets: Uncertainty has been the main feature of the currency markets over the past month. The dollar has recovered from earlier weakness after the Fed made only very modest changes in its monetary policy at the latest OMC meeting, and is ending the period basically unchanged; sterling has weakened slightly against the dollar but is higher against the euro; and the euro has also fallen back against most other currencies as the fears about sovereign debt defaults in Europe have increased.

But the feature of the currency markets over the month has been the sharp appreciation of the yen because of its enhanced “safe haven” status. The move is obviously an unwelcome development for the Japanese authorities, and there has been considerable speculation about intervention by the Bank of Japan to reverse it; but there has been no action so far.

Short-Term Rates: There have been no changes in short-term rates in the major financial centres this month. Commodity markets have followed the trend in the other markets, improving in the early part of the period, but falling back towards month-end. The main features have been the continued strength of wheat prices after the Russian decision to suspend wheat and grain exports, and the sharp fall in oil prices.

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