"Budget confirms a dismal outlook for the UK" by John Redwood, Evercore Pan-Asset, 24th April 2009

April 24, 2009 - PRLog -- The UK budget confirmed our worst fears. Where it was more realistic, in the forecasts for growth and borrowing in 2009, the figures were poor. Where it is more optimistic, in its forecasts for growth and borrowing after 2011, it was unbelievable. Like many other commentators, we not think the UK will spurt back to growth above 3% and stay there.

The central figures for borrowing in 2008-9 and 2009-10 were at the very bad end of market forecasts. Over the two years together the government has to borrow £417 billion gross. The following years will continue to see large increases in debt. Public spending in the last two years of the current Parliament remains on a strongly upward trend, to be followed by years of austerity under Labour plans with practically no growth at all.

We do not see the case for investment in UK fixed income government bonds at current interest rates, unless the bond is bought for matching purposes and held to redemption. Whilst it is  true that the banks will be made to buy a lot more short and medium dated government paper under new regulations, and whilst it is true the Bank of England itself will buy some more under its quantitative easing programme, the debt issuance is very large. At some point the Bank has to sell all those gilts it has bought under the QE programme back to the market, or the government has to issue replacement bonds.

Inflation may fall further this year, but the RPI falls are very dependent on the one-off effect of much lower interest rates. Meanwhile the CPI remains well above target as the full effects of sterling weakness work through. The government itself will also raise more prices, as it is planning with the reintroduction of the fuel escalator.

The large public deficit, the rising tide of public debt and the uncertain path for getting back to fiscal balance will act as a constraint on growth in the UK. Investors and companies will fear more tax increases, and will understand the cruel logic of compound arithmetic as more debt is issued and more interest falls due. The budget confirms our view that investors are better off investing in equities elsewhere, and confirms our view that government debt is no longer attractive.

The tax increases on higher earners and upon higher rate contributions to pension funds make the UK a less attractive place for entrepreneurs and new businesses. A favourable regime for such activities which was in place with 10% gains tax and 40% income tax has been made much less competitive by the increase to 18% and 50%. There are now larger incentives for portfolio investors to make gains rather than drawing income, to the extent that tax law allows.

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We belive that carefully considered asset allocation decisons is the cruicial part in the investment management process and argue that identifying the correct asset classes in which to invest is more important than selecting the underlying stocks.