Evercore Pan Asset

The biggest change in the UK budget announced on Wednesday is the decision to borrow £34 billion more over the five years of this government’s strategy up to 2014-15.  Total spending is forecast to be £6 billion higher in Year five compared to the last budget.  The government also plans to spend £10.6 billion more in 2011-12, £9.2 billion more in 2012-13 and £8.1 billion more in 2013-14. 
 
The government will have to raise an additional £485 billion of debt over the five years, increasing the official debt by around a half. The strategy still rests heavily on achieving above trend growth from 2012 until 2015. The Office of Budget responsibility believes this is likely and confirms so with its forecasts for growth of 2.7% or higher in each of those years starting in 2012-13. 
 
The government also needs to refinance substantial quantities of debt. The total financing requirement in 2011-12 will be £167.4 billion, including £49 billion of government bond redemptions that need to be replaced.  The Office of Budget Responsibility forecasts short term interest rates rising to 4% by 2014-15, and average gilt yields rising steadily from 3.8% this year to 4.9% in the fifth year of the policy. On this basis it would be unwise to hold gilts, as clearly the official forecast is for substantial losses on longer dated stocks, and smaller losses on shorter dated, as the interest rate adjustment takes place. We do not currently hold gilts for clients unless there are special requirements. 
 
The theme of the budget was a budget for growth. The government is well aware of the need to do all they can to stimulate business and enterprise to achieve the growth forecasts central to the strategy. The tax changes for companies other than oil, gas and large energy users will be helpful. The change to the treatment of foreign profits may arrest the exodus of footloose companies and may attract some back to the UK. The package for entrepreneurs has been improved, but the 52% top tax rate remains subject to a Treasury review of its impact on revenues. The government has promised substantial domestic deregulation, but investors will need to watch for the subsequent detail. EU regulation continues to increase. 
 
The UK equity market remains reasonably rated, offering a good yield at a time of low interest returns in many markets. The OBR forecast assumes higher share prices in the years ahead, despite the move to higher interest rates. The UK market remains dominated by large companies with substantial overseas earnings, where the state of the global economy has an impact. The UK recovery will continue, with higher interest rates and a relatively high inflation rate as headwinds. We do not think as some do that the Chancellor has cut too much. Whilst the spending figures are tight by past UK standards, spending in cash terms is rising and has been boosted by the budget. The risks in the strategy lie in the reliance on growth at a time when there are global uncertainties about the world economy next year and beyond, and in the substantial amounts of new debt that have to be issued against a background of rising interest rates.