Could Hammond’s First Autumn Budget be His Last?

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The UK Chancellor of the Exchequer Hammond is set to deliver his first Autumn budget tomorrow, and it could be his last.  The UK government is fragile.  Infighting is notorious.  It appears the hardline Brexit camp does not trust Hammond.  A cabinet reshuffle is widely rumored, and Hammond seems vulnerable. Prime Minister May, who also initially was in the Remain Camp, is said to regard Hammond suspiciously.  

Hammond is understood to be fiscally conservative, but he is hemmed in by the slowing economy, Brexit uncertainties, and a weak government.  His proposal in the spring to have small businesses pay more for National Insurance fell flat, and it was quickly retracted.  Another faux pas and his fate in the government could be sealed.

He may tempt the Fates if he challenges Entrepreneurs’ Relief, which allows directors of companies who own more than 5% of the company to pay just 10% tax on capital gains.  The scheme is essentially designed to give small business owners a tax break but has been accused of being open to abuse in the past. If Hammond sets up curbs tomorrow, as some expect,  business owners and entrepreneurs may seek his head.

Rising house prices in the UK are partly a function of a shortage.   Hammond could allow building in areas that are currently restricted (green belt land).  Hammond may also cut the stamp duty (transaction tax) for first-time home buyers.  The Chancellor may also commit funds for R&D and technology.

The UK government is already on the hook for GBP500 mln for the next two years for Northern Ireland as the price of the Democrat Unionist Party that lends support to the Tory government that lost its majority.  The government is committed to lifting the 1% cap on the salaries of some public sector employees.  The ceiling on university tuition fees will be frozen next year, and the earnings limit before student debt needs to be repaid is expected to be increased.

While important for selected constituencies, the budget is expected to be small beer.  Projections of weaker productivity translate into weaker growth, which in turn weighs on revenues and gives the Chancellor little room to maneuver without boosting the deficit.   Last year was the first year since 2007 that the UK recorded a budget deficit less than 3% of GDP.   It is expected to be little changed this year.

UK primary dealers expected the Debt Management Office to cut projected issuance by GBP720 mln from the GBP114.2 bln projected in the spring.   This is also small beer but could see long-term yields slip if true.  There had been some talk that the MPC’s target is shifted to CPIH, which includes homeowners occupation costs from CPI,  following the Office of National Statistics, but Hammond’s office seemed to play down this possibility.   CPI stood at 3.0% year-over-year last month.  CPIH was at 2.8%.  On the margins, lower inflation may be seen as favorable for gilts but negative for sterling.  Recall that Lawson had shifted away from the Retail Price Index, which is still used for some things including inflation-linked securities, public housing rents, and some student tuition.  The RPI rose 4.0% in the year through October.

The most important element of the budget is not about economics but politics.  Many observers see the budget as one of the last opportunities the Tory government has to bolster its support.  Reports suggest that as many as 40 Tory members of Parliament are prepared to sign a letter of no confidence in May, eight shy of the threshold to trigger a leadership challenge.  Given the difficult straits that any government would find itself, it may be a poisoned chalice.  Many investors fear that the only thing worse than the Tories would be a Labour government.