28th March 2011

BNY Mellon: Threadbare budget offers few surprises

Peter Hensman, global strategist at Newton, and Richard Wilmot, manager of the Newton Income Fund, give their views on Wednesday's budget.
“The clear winner from George Osborne's budget is UK business," says Wilmot. "A number of the measures announced are encouraging the private sector to invest and take up the slack as the state shrinks; this is a welcome move as well as a necessary one. Furthermore, the extra cashflow should enable them to invest with more confidence, and this in turn is good for both economic growth and the employment cycle," he adds.

From an economic perspective, Hensman believes that the budget contained few real surprises. He explains, "The budget had a focus on business- and export-led growth to lead the UK's economic recovery, along with a smattering of concessions to ease some of the pain being endured by the UK consumer. Indeed, with corporation tax being cut once more, and the UK consumer bearing the brunt of VAT rise at the turn of the year, there is a clear attempt to encourage employment creation in the hope that this will help consumers deal with the squeeze caused by the need to raise tax revenues.

“However, in reality, this budget changes very little," says Hensman. "We are in year one of the government's five year plan to sort out the country's huge fiscal deficit, and the Chancellor has made it abundantly clear that there is no plan B," he says. "Given the perilous state of the UK economy, any deleveraging on this scale will inevitably be challenging, so it would be foolish to expect the problems to disappear after just 12 months of belt tightening.

“Furthermore, there is no cast-iron guarantee that the prescribed government cuts will be sufficient." Hensman explains, "By 2015, and on the current plans for spending cuts, government outlays will be 41% of UK GDP, the same level it was at in 2005 after the last government had allowed a large increase in spending. Despite these austerity measures, the country will still be running a fiscal deficit. That said, we believe that Osborne is correct in his view that market patience with the UK cannot be guaranteed indefinitely, so action to avoid this at all costs is very much a necessary evil," he adds.

Inflationary fires
The struggling UK economy also faces problem of rising inflation, owing much to increasing global commodity prices. "While in the run-up to the global financial crisis, house price inflation was enjoyed by homeowners, now, external inflation provides a much harder task to contend with," says Hensman. "Against this backdrop, the Bank of England (BoE) faces a delicate balancing act between trying to prevent consumer prices from spiralling out of control, and intervening too much and stalling the still fragile UK economy that has yet to see a significant reduction in private sector debts despite the credit crunch.

“The BoE is not in an enviable position, and is faced with a situation in which the risks of policy error are great. The likelihood is that given the focus of policymakers on avoiding deflation at all costs," Hensman concludes, "the UK consumer can look forward to a fairly uncomfortable experience as the UK economy moves slowly towards a sustainable recovery."

Investments