By GRAHAM FROST 10/06/2010
The Con-Lib Coalition has announced its first budget will be held on 22nd June 2010 with a spending review to follow in the autumn.
Some measures have been announced already; cutting ministers’ salaries as well as senior civil servant and NHS bonuses by two thirds in the drive to save £6 billion this year. But that is small in relation to a deficit of £156 billion. Indications are that a 5 year plan will be outlined to return it to manageable levels. The International Monetary Fund estimates that the UK would need to cut its deficit by 1% of Gross Domestic Product or £14 billion a year for 10 years to reduce it to sustainable levels. That level of cuts, let alone anything faster, would almost certainly cause recession.
Inevitably there will be job cuts, falling mostly in the public sector which is simply too big for us to afford. These cuts are likely to be mirrored to differing degrees across Europe and America going into 2011. Economic growth, if any, will be hard to come by as it will be difficult for the private sector to offset the public sector shrinkage. Osborne may provide some incentives for business in an attempt to make the environment conducive to investment by local and foreign business. Will banks become low growth utilities under a raft of regulation and tax levies? A more measured policy is likely on capital gains tax to encourage entrepreneurship. The ideal approach to erode a fiscal deficit is by growing the tax base, not shrinking it.
Increased taxation coupled with spending cuts tends to be deflationary. We do not expect inflation to become a problem for some time in the developed world and in the UK, unless sterling weakens significantly even more. As a result interest rates can stay lower for longer, until surplus capacity is eroded, banks start lending again, employment rises and growth resumes.
Consumers will remain under pressure with any wage increases below inflation. Locally focused UK and Europe, our major trading partner, based businesses are likely to have a tough time. So, growth in earnings will be difficult to come by for such firms. Investors should look to larger companies that have defensive characteristics or significant exposure to the faster growing regions in the world. With interest rates low, the defensive income qualities of bonds should retain some appeal. We prefer corporate bonds over government bonds for better income yield and less supply. Sterling will mirror economic weakness so an internationally diversified portfolio remains advisable. Markets are likely to remain volatile as investors digest implications for profitability, so hedge funds that can exploit short term trends are recommended.
Recommended Funds
Invesco Perpetual Tactical Bond
Rensburg UK Equity Income
Standard Life Global Absolute Return Strategies
First State Asia Pacific
If there is anything you wish to discuss please call one of our Investment Professionals on 020 7189 9999.