Chancellor Rishi Sunak delivered a “sobering picture” of the UK economy in his one-year Spending Review, with Covid-19 leaving “long-lasting” scars, according to industry commentators, who predict that this further round of spending will need to be paid for through higher taxation.
“The Chancellor spelt out quite clearly the extreme damage that has been done to the economy; the numbers are frightening,” Neil Birrell, CIO at Premier Miton Investors, said.
Sunak confirmed to the House of Commons earlier today (25 November) that the Office for Budget Responsibility (OBR) has forecast the economy will contract by 11.3% this year – the biggest decline in 300 years – rising to 5.5% next year.
“After the forecast bounce next year and in 2022, growth will fall back again just over 2%, then back below 2% for the next two years,” Birrell said. “This illustrates that the scars are long-lasting; the scale of debt and unemployment are fundamental to the problem.”
Hinesh Patel, portfolio manager at Quilter Investors, added: “The Chancellor today laid out a sobering picture for the UK economy, with scarring looking like it will become increasingly evident.
“Unemployment is expected to get dangerously high, at 2.6m people, and it is this that Rishi Sunak will be looking to prevent turning into a long-term trend.”
Sunak also revealed that borrowing this year has reached £394bn.
Richard Carter, head of fixed interest at Quilter Cheviot, said this was “completely unsustainable and will likely lead to higher taxation down the line, but those decisions will have to wait until the Spring”.
In his Spending Review, Sunak announced that government spending to tackle Covid-19 amounted to £280bn and that it will spend a further £55bn for public services next year.
According to Jason Broomer, Square Mile’s investment director, this equates to £5,000 per person.
Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, called the chancellor’s Spending Review a “brutal assessment of the damage wreaked on the economy by Covid-19”.
“The FTSE 100 dropped further from recent highs after the Chancellor Rishi Sunak was speaking as the scale of the problem was laid bare amid worries about the outcome of the fraught Brexit negotiations,” she added.
She agreed that tax rises further down the line look increasingly likely, “even though they may be politically hard to deliver”.
RPI to be reformed in 2030 but no compensation for gilt holders
“The government has already ruled out all sorts of potential tax rises, including changing the pensions triple lock. So it looks like capital gains tax and pensions tax relief could be a target,” Streeter added.
Trevor Greetham, head of multi asset at Royal London Asset Management, added: “We’re left with the impression that we are going to see permanently higher debt levels, continued financial repression with interest rates kept artificially low and a higher trend in inflation.
“For investors this means persistently low interest rates and a positive outlook for assets like equities, property and commodities which have a good track record in beating inflation over the long run.”
Investment in infrastructure
The chancellor delivered his announcement about a new National Infrastructure Strategy and UK Infrastructure Bank towards the end of his Spending Review, pledging “record investment plans”, with £100bn of capital spending next year.
Streeter said: “Supercharged spending on capital infrastructure projects may seem extravagant when the debt burden is so high, but investment in technology to power the future should help create jobs that are desperately needed right now.
“A new infrastructure bank should help draw in new streams of funding, but may take time to generate interest, given there has been a distinct lack of appetite to invest in UK assets.”
RPI reaction
Quilter Cheviot’s Carter said that markets had been “closely watching” the Chancellor’s announcement on RPI, “which affects a whole range of assets including index-linked gilts”.
“In the event, the government has decided to align RPI with CPIH from February 2030 but will not be paying compensation to holders of index-linked gilts,” Carter explained.
“So far the reaction has been relatively modest, suggesting the move was largely discounted already.”