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The ongoing US government shutdown (about which markets do not yet care one iota) means that there is no new data out of the US. We did, however, have some good UK retail sales numbers this morning and UK inflation data came in below expectations on Wednesday. The latter is important as higher inflation is the reason interest rates here are over 2% higher than in the Eurozone, even though our underlying growth rates are very similar. And these higher interest rates mean higher borrowing costs for the government and so higher taxes.
And on this topic, our UK based clients will no doubt be aware we have a budget coming up soon. It looks like tax rises might be at the higher end of the £20bn-£30bn range (or come in at around 1% of GDP). For the detail-oriented, here is Goldman’s list of what Labour might do to get there. I’d note that £30bn is roughly equivalent to adding 3p onto income tax across the board (but for obvious political reasons this is not how they are going to do it):
Please note these examples are purely for illustrative purposes which may or may not come into effect. You should always seek professional advice before taking any action on potential tax changes.
One frustration here is that one reason taxes are going up is because the Office for Budget Responsibility (OBR) has downgraded its long-run growth rate assumptions. Higher taxes do not help long term growth rates!
A second gripe is that higher interest rates in the UK (vs the US or Eurozone say) translate into higher government borrowing costs and so higher taxes. And here I would note that the Bank of England has sold over £300bn of gilts in the last 3 or so years and plans to sell £70bn next year (this selling is called Quantitative Tightening or QT in the jargon). Bond selling pushes up interest rates and so government borrowing costs. And this balance sheet reduction has been more aggressive than the QT programs at both the Fed or the ECB:
This has of course pushed up bond yields and so increased all of our tax bills. This does not feel like an optimal policy mix to me. I am hoping that the good news we saw this week on inflation will continue and we will see some of this effect reverse as bond yields (and government debt payments) start to fall again. But this is not where we are today.
The attentive among you will have noticed I am complaining about central bank policy here. So, in the interest of balance, let me also defend them against one of the more popular recent criticisms thrown at them. QT is bond selling (or taking liquidity out of the system). It is the opposite of Quantitative Easing (QE) which bought bonds and so pumped money into the system for much of 2010-21. The criticism then was that this money didn’t really help the economy but just pumped up asset prices. Or, to put it another way, central banks were just inflating an equity market bubble to help their friends on Wall Street. I think the experience of the last three years pretty much proves this idea was wrong. We have had three strong years of equity returns even as central banks have been sucking liquidity from the market. Here is the Fed balance sheet compared to equity prices for example. Whatever was pushing up equity prices in the 2010s, it wasn’t central bank money printing.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
