By GRAHAM FROST 23/06/2010
The budget proposals announced yesterday confirmed government intentions to move faster on deficit reduction through a combination of increased taxation and reduced expenditure.
Pre budget estimates suggested an austerity package of £80-85bn over five years (£30bn more than previous governments’ proposals) - this has now been confirmed. The emphasis is firmly on spending cuts with the axe falling primarily on the public sector and benefit entitlements, combined with a redistribution of the tax burden and tax increases.
Our view was that the government would also have to adopt some pro-growth policies to offset the dampening impact of these measures on the broader economy. We expected this to come mainly in the form of tax incentives for businesses, this has also proved to be the case with reductions in Corporation Tax, concessions on National Insurance duty and a raising of threshold for Entrepreneurs Tax. To compensate, banks have been targeted, with the introduction of a bank levy from 2011.
In light of the budget proposals, the new independent Office for Budget Responsibility (OBR) has revised UK GDP growth estimates downwards, but still expects growth of 1.2% for 2010-11 and 2.3% in 2011-12. The Treasury acknowledged that their measures were likely to have a short term negative impact on growth estimates; however they argue the steps taken today should not have lasting consequences and will provide room for faster growth rates into the future, setting the scene for the Bank of England to leave rates lower for longer, whilst inflation remains muted. But given the stresses that still remain in the financial system, the outlook for UK, and for that matter world growth on which the UK recovery is partly predicated, remains highly uncertain and the range of outcomes potentially wide, a challenge the OBR recognises in the low probability it has attached to their forecasts.
From an investment perspective we remain of the view that inflation pressures will be contained and interest rates remain lower for longer; against this backdrop quality corporate bonds will continue to find support from investors. Equity earnings growth is likely to be more difficult to come by, consequently our preference is for larger more defensive companies that offer secular growth prospects. Poor economic fundamentals and a weak sterling tend to go hand in hand, so an internationally diversified portfolio is also advisable. Above all, markets are likely to remain volatile given ongoing sovereign concerns in Europe, which should benefit select hedge fund strategies.
Recommended Funds:
Invesco Perpetual Tactical Bond
JO Hambro CM UK Opportunities
Standard Life Global Absolute Return Strategies
First State Asia Pacific Leaders
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