The UK’s recent budget has attracted a great deal of interest on numerous points. In our opinion the key points are that the UK’s borrowing, as a percentage of GDP, will continue to rise over the next couple of years, that debt as a percentage of GDP will rise from approximately 76% this year to approaching 86% in 2016/17, and that forecast growth has been cut from earlier predictions.
In essence, all of this points to continuing slow progress for the UK economy for some years to come, and the lesson is that the balance sheet crisis that this country and others, notably the USA and parts of Europe have seen, cannot be quickly resolved unless growth elsewhere in the world is sufficient to generate a great deal of widespread demand.
From this it is clear that investors need to take a global perspective, and while the Eurozone remains in difficulty, a better picture is now emerging in the USA. In many of the rapidly developing economies levels of growth, although below their previously unsustainable highest levels, still remain encouraging.
I will comment further on our views for the outlook for investors in the last section of this newsletter, but in the meantime there are some specific budget related points that I would like to comment on:
Individual Savings Accounts
For 2013/14, the ISA allowance will increase to £11,520, of which £5,760 can be invested in a Cash ISA. Taking into account the tax advantages that ISAs carry, my recommendation is that all clients should invest in an ISA at the beginning of the new tax year rather than at the end. The reason for this is simple – you will receive the best part of an extra twelve months tax efficient growth.
The VAT rate remains unchanged.
The personal allowance for those under 65, will rise from £8,105 to £9,440 in 2013/2014, and is set to rise to £10,000 in April next year. While the basic rate of tax 20% remains unchanged, the basic rate limit falls from £34,370 to £32,010 as a consequence of the increase in the personal allowance. The 40% rate remains unchanged and the 50% rate on incomes over £150,000 will fall to 45%.
The rate and the tax band remain unchanged at 40% and £325,000 respectively, the latter until April 2018, and this is four years longer than had previously been expected.
CAPITAL GAINS TAX
The annual exemption of £10,600 remains unchanged this year as do the 18% and 28% tax rates, but it will be increased by 1% a year in 2014/2015 and 2015/2016, to £11,000 and £11,200 respectively.
The basic state pension will rise from £107.45 to £110.15 in April, an increase of 2.5%.
A number of significant changes are planned to both state pensions and private pensions but these are complicated and are beyond the scope of this newsletter. However, in brief, they include a new flat rate state pension of £144.00 per week, due to start for those becoming eligible in 2016, a year earlier than expected. The amount that individuals can contribute to personal pension schemes each year, whilst still benefitting from tax relief at their highest marginal rates, will fall to £40,000 from £50,000 in twelve months’ time. The lifetime allowance will fall from £1.5 million to £1.25 million, and from April this year the maximum tax relief available will fall to 45%.
Investors in Self Invested Personal Pensions (SIPPs) cannot currently hold residential property within their scheme, but the Government is planning to explore changes to the rules to encourage the conversion of unused commercial property in town centres to residential use. This may result in a change to the rules in due course, but the outcome will inevitably be complex and may well prove unsuitable for many SIPP investors.
LONG TERM CARE
The Government has announced plans that will provide a degree of certainty when planning for the high and unpredictable costs of long term care. A cap, reduced in the budget to £72,000, will be introduced from 2017 and care costs beyond that figure will be paid for by the Government. A key point is that the figure does not include what have been labelled “hotel costs”, which will have to be met out of one’s own resources, but nonetheless the new scheme represents a potentially very significant improvement for many.
BUSINESS TAXES AND INCENTIVES
A further cut in Corporation tax, by 1% to 20% from 2015 was announced in the budget together with beneficial changes to employer’s national insurance contributions. The Government have announced that every company in the UK will be able to get up to a £2,000 reduction in their National Insurance contributions. This will be particularly significant to smaller companies.
Other measures include a range of activities that look almost certain to boost house building over time (which in turn generates a range of spin-off economic activity), through to announcements in respect of additional funding for capital investment and the tax relief to encourage development of the UK’s potentially significant gas reserves. On balance, I consider it to of been a reasonable budget for businesses and therefore of potential benefit to investors.
It is of course impossible to realistically précis the content of a complicated budget onto just a few paragraphs, but it is clear that, as a trading Nation, the Government’s finances continue to be impacted by events across the Channel which provide an unhelpful headwind.
As was widely reported, one of the major international credit rating agencies very slightly downgraded the UK but at the same time confirmed that it regarded the outlook as stable, and other agencies may follow suit. Perhaps as a consequence of renewed European problems, gilt yields have stopped rising, at least for the moment, and Sterling has steadied in foreign exchange markets. However, gilts offer a negative return after inflation has been taken into account, as does cash in the bank, and neither asset class holds long term appeal. In the short term however it is possible, or perhaps likely, that the Bank of England’s QE Scheme will recommence and the level of the issuance of gilts by the Government over the next twelve months may well reduce. Therefore whilst gilt prices may not significantly fall in the short term, I can see no real likelihood of their rising to any great extent either. They remain an asset class which to my mind holds little attraction apart from the index-linked variety, as inflation remains a material concern in the medium and longer term, fuelled by Sterling’s sharp devaluation in recent years.
Fixed interest investments issued by companies, called corporate bonds, do offer rather better levels of yield than gilts, and in the short term values look relatively secure as pressure to keep interest rates at low levels remains. In the longer term I remain concerned that fixed interest values may be eroded as and when we do see a return to rather more commercial rates of interest.
Equity markets have remained broadly positive in the face of renewed Eurozone problems surrounding the tiny economy of Cyprus where perhaps the relevance of the drama at an international level has been exaggerated, except in respect of again highlighting the need for the Eurozone to further integrate its governance and banking structures.
In the meantime, both UK based and International companies, with some exceptions, continue to grow profits and dividends while strengthening balance sheets and benefitting from the continuing cheap money regime – these points applying to globally focused companies broadly irrespective of where they may be based. I believe, therefore, that while over the last few months equity prices have rallied, good value is still to be found in many markets and my preference for higher equity weightings within portfolios, which has added value in recent years remains in place. Finally, it is worth remembering that the trend towards a lower value for Sterling has an overall positive impact on earnings.