Since the depths of the post-budget market rout last September and October, the sense of pessimism about the outlook for the UK economy has lessened. Whilst raising interest rates to a 14-year high of 4% in February 2023, the Bank of England forecast economic output would fall by just -1% through 2023, which, while not good, is ‘less bad’ than they were forecasting previously. The National Institute of Economic and Social Research and the Office for Budget Responsibility believe that the UK is likely to avoid a recession this year, although the former noted that “with GDP growth set to remain close to zero in 2023 and real personal disposable income having contracted for four consecutive quarters, it will certainly feel like a recession for many.”
Whilst we remain in a cost-of-living crisis, the UK consumer (in aggregate) has proven to be more resilient than expected and spending remains relatively healthy. In addition, the jobs market continues to be robust with unemployment of just 3.7%, close to the lowest rate since the 1970s. A combination of Brexit, Covid, health and early retirements means there are currently more jobs available than people looking for them. It is unusual to have a full-blown recession when people can still earn a living and companies are less likely to make staffing cuts if they believe they will struggle to re-hire people.
The Bank of England expects the headline rate of inflation to fall rapidly as peaks in gas, oil and agriculture prices due to the Ukraine invasion early in 2022 fall out of the calculation. Inflation could fall to 2.9% by the end of the year, dropping to 1% in 2024. Interest rates could rise to 4.5% in the spring before a series of cuts next year to prop up the economy, assuming inflation has fallen. However, the UK faces ongoing challenges and growth is likely to remain low in the next few years due to a combination of staff shortages, higher energy costs, higher interest rates and higher taxes.
In the US, consumer spending, business activity and the jobs market remain robust, suggesting that the US economy is some way off recession but also that the rising interest rate cycle could have further to go. China has now removed most of its Covid restrictions, which should further help to reduce global supply constraints, ease inflation and boost activity in the Asia region.
Generally, around the world, consumer balance sheets are weakening but remain positive, corporates are relatively healthy and not overly indebted, jobs markets are strong and business activity indicators continue to show some growth. This suggests a scenario where economic growth is low but positive, inflation falls but remains higher than we have been used to in the recent past and interest rates are not far from peaks but could remain higher for longer.
Markets
With the ‘less bad’ narrative dominating recently, most assets had been more positive over the last three month with the FTSE All Share, for example, rising by 5.25% between 1st December and 7th March.
Unfortunately, the plight of a small, niche bank in the US has created a sudden climate of fear and knocked markets. Silicon Valley Bank (SVB) was relatively small in banking terms (less than $250bn assets) and focussed heavily on providing finance for and taking deposits from technology companies mostly, but not exclusively, in Silicon Valley in the states. Concerns about its ability to repay deposits led to a run on the bank, requiring it to sell some of its holdings in US government bonds at a loss, which led to more depositors asking for their money back and a liquidity issue. The US Federal Reserve and Treasury stepped in, took over the bank and have guaranteed all depositors money. Concerns have since spread to other small US banks and more recently Credit Suisse which has received an emergency loan from the Swiss central bank to ensure it has sufficient liquidity.
These events have had an impact on banking shares and stockmarkets overall, with the FTSE All Share erasing most of its gains for the year so far. The loss of SVB, whilst the catalyst for the recent falls, was not really the reason. Arguably, with only a single type of customer (tech), there was always the potential for a liquidity issue if the tech sector suddenly needed funds and risk-management did not seem to be high on the banks priority list. Equally, the chances of another banking crisis are slim – rules imposed after the 2008/09 crisis mean that major banks are much better capitalised and central banks run stress-tests regularly to ensure they can cope with issues. The larger issue is the unknown risks following the reversal of fourteen years of cheap and plentiful money (through low interest rates and quantitative easing). There were always going to be some corporate casualties following steeply rising interest rates and much tighter money supply but, at the moment, this does not look like a systemic (market wide) issue.
Markets are, however, likely to remain volatile whilst central banks continue to battle inflation and tighter monetary policy starts to impact economies. As the year progresses and assuming inflation continues to fall, the upwards pressure on interest rates should subside which could provide relief for markets.
For the first time since the late 2000’s we have interest rates, bond yields and dividend yields at similar levels. This is likely to result in larger swings between asset classes over short periods as relative value waxes and wanes, but retaining a well-diversified portfolio provides exposure to a broad spread of potential returns.
Tax reliefs
In the Chancellor’s budget last November (the second one, not the Kwasi-catastrophe), there were a few changes to tax relief’s which may have gone unnoticed given the other events happening at the same time:
- The annual Capital Gains Tax allowance is being cut from £12,300 currently to £6,000 in 2023/24 and then just £3,000 in 2024/25.
- The annual dividend tax allowance reduces from £2,000pa currently to £1,000pa in 2023/24 and £500pa in 2024/25.
- Dividend tax rates have been increased by 1.75% across each band (8.75% basic rate, 33.75% higher rate)
Taxable interest
One of the benefits of the current situation is higher interest rates than we have seen for over 14 years. Many standard deposit accounts are offering interest rates of 3% or more, with rates of up to 4% available on termed deposits for 2-3 years. However, this does raise an issue that we have not had to face for a while – tax on deposit interest!
Since April 2016, all interest has been paid gross (pre-tax) with individuals responsible for notifying HMRC and paying any tax due. With the £1,000pa per person ‘personal savings allowance’ and historically low interest rates, this has not been a problem for most people. However, at 3% interest, balances over £33,333 will receive interest of more than £1,000pa. If you are in this position and not using ISA allowances elsewhere then cash ISAs can help shelter £20,000pa per person. Premium bonds from National Savings also provide a tax-free return in the form of prizes rather than interest. There is no guarantee of winning but the prize rate (a benchmark of the “average” return) is currently 3.3%. Also, splitting deposits as equally as possible between spouses/partners ensures you are maximising the potential savings allowances.
You pay tax on any interest over your allowance at your usual rate of Income Tax. If you receive any income through PAYE (salary/pension), HMRC will change your tax code so you pay the extra interest tax automatically, although it would be prudent to contact HMRC to confirm your total interest payments if they are over £1,000pa. If you complete a Self-Assessment tax return, report any interest earned on savings there.
If you receive less than £10,000 in dividends or interest there is no need to register for self-assessment, you can simply report the amount directly to HMRC (if you can get through on the phone).
Budget 2023
We’re still waiting for the dust to settle on the most recent budget as the devil is always in the detail but they key highlights from a financial planning perspective were:
- The pension Lifetime Allowance will be effectively abolished (at least no charges apply) from 2023/24. This was unexpected and intended to stop the exodus of GPs and NHS specialists into early retirement. This may face opposition in Parliament and labour have already stated they would reverse it (with an NHS exemption).
- The annual allowance, the maximum a person can contribute to a pension in one tax-year, is being increased from £40,000 to £60,000.
- The impact on the annual allowance for high earners (Tapered Annual Allowance) is being relaxed.
- Corporation Tax is being increased from 19% to 24% with reliefs available for those earning between £50,000 and £250,000.