Britain faces slowing growth, high inflation, and higher than expected government borrowing.
It’s not a pretty picture. And it’s a testament to what a smooth political operator George Osborne is that this wasn’t the main message to come out of yesterday’s Budget.
The fact is, Britain faces tough times ahead. The best we can hope for is that the politicians in charge don’t make it any tougher by messing things up.
The good news is, the coalition seems to be heading in the right direction. The bad news is, that’s not going to make life any easier for investors in the short term.
So what should you be doing to protect yourself?
Inflation is already damaging growth
The backdrop for the Budget wasn’t promising. Growth is set to be slower, and borrowing higher. Much of this is to do with inflation. On the one hand, it is cutting into real, inflation-adjusted incomes. On the other, it is driving up the cost of welfare spending and also the interest costs on index-linked gilts. So it’s squeezing the government as well as the rest of us.
As Allister Heath rightly points out in City AM this morning, this shows the danger of letting inflation get out of control. Those who oppose interest rate hikes argue that any raise would ‘derail the recovery’, and yet inflation is already sapping growth.
But despite the gloomy outlook, as my colleague David Stevenson noted yesterday: 2011 will be tough for UK consumers – even with petrol price cuts, the chancellor managed to keep the markets happy. The yield on ten-year gilts was little changed between him standing up to speak and when he sat down. The pound slipped back, but that was as much to do with the Bank of England minutes being less supportive of a rate hike than expected.
Of course, markets don’t have much choice right now. Britain has a troubled economy, but we’re not the worst off. Osborne might have felt under pressure yesterday. But in Portugal, the rejection of the country’s latest austerity budget saw prime minister Jose Socrates resign. We’ll have more on that as the story develops, but it’ll certainly make the current meeting of Europe’s bigwigs over the structure of the bail-out fund more exciting.
A step in the right direction
The fact is, 2011 was never going to be an easy year for the British economy. And things could get worse from here. As credit rating agency Fitch pointed out, the UK growth forecasts are still quite ambitious given the wobbly state of the global economy. If inflation gets worse than expected (which is very possible), or growth falls, then we could need more tax hikes or spending cuts to compensate.
But as Roger Bootle put it in The Telegraph, the idea that the chancellor (or the Bank of England for that matter) has a magic wand that will make all our economic problems disappear is “part of the mindset which got us into our current difficulties”. So, as I mentioned earlier this week, the best we could hope for from the Budget was a sense that we’re at least moving in the right direction. The good news is, that’s what we got.
The 50p rate of income tax might be staying for now, but it’s not permanent. The tax system doesn’t look much simpler yet, but Osborne has at least decided to open the can of worms that is merging National Insurance and income tax.
The bigger-than-expected cut in corporation tax should be an encouraging sign to companies that might have been wavering over whether or not to invest in the UK. And entrepreneurs will now be taxed at just 10% on their first £10m of capital gains, from £5m before.
There were still some unwelcome stealth moves. Increases in the income tax and National Insurance thresholds for example, will from 2012 be calculated based on the consumer price index (CPI) rather than the retail price index (RPI). CPI tends to rise more slowly than RPI, which means that over time, people will become higher-rate taxpayers more quickly. It’s a fiddle Gordon Brown would have been proud of, and Osborne reckons it’ll pocket him an extra £1bn or so by 2015.
But on the flipside of that, the personal allowance is set to keep rising, removing increasing numbers of low earners from paying income tax at all. And that’s got to be a good thing.
So what should you be doing as an investor?
In the grand scheme of things, the fact that the budget was fairly business-friendly is good news.
The cut in corporation tax should be good for the big blue-chip dividend-paying stocks we favour. And elsewhere, Enterprise Investment Schemes are getting even better tax breaks, and will be able to invest in bigger companies. We’ve always been wary on these because the underlying investments tend to be very risky, but they may become more attractive now – we’ll have to wait and see what’s on offer.
But overall, it doesn’t make a huge difference to what you should be investing in. The various threats facing the global economy still call for keeping your portfolio defensively positioned. And despite the cut in fuel duty, inflation is still set to be a major threat to the UK economy.
From that point of view, the most interesting thing to come out yesterday was the news that National Savings & Investments will be bringing back its savings certificates in the new tax year (which starts in April). We don’t yet know what precise rate will be offered on the new bonds. But if they are anything like the old ones (which generally paid 1% above RPI inflation), they’ll be worth queuing up for.
The point is, investing is a long-term game. You shouldn’t have to chop and change it with every new Budget, and the fact that you don’t this time around is a good sign. My colleague Simon Caufield was writing about the most important rules of investing earlier this week, in a piece which proved very popular. If you missed it – plus his free report on value investing – you really should take five minutes to read it now: The worst investment mistake you can make.
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