Cuts to deficit will calm Moody’s nerves

 
Ashraf Laidi
CHIEF GLOBAL STRATEGIST, CITY INDEX

THE UK Budget has the basic requirements to keep credit agencies at bay – for now. The plan is to enact a 7 per cent stamp duty on property worth more than £2m, slash the main corporate tax rate to 24 per cent, lift the personal allowance by £1,100 to £9,205, and bring in a much-telegraphed reduction in the top tax rate from 50 per cent to 45 per cent. With the Treasury estimating it would lose £2.4 bn in tax avoidance this year, the combined effect of returning tax avoiders may well give an inflow boost, or a mini-stimulus ahead of election year.

Government borrowing is expected at £126bn, only £1bn lower than the Office of Budget Responsibility’s autumn forecast. The government insists debt will rise by £11bn less than was forecast in the autumn over the next five years, taking the budget back to surplus over the same period.

But in order for the debt part to be slashed, the growth portion must ameliorate, or at least hold. The OBR nudged up its 2012 growth forecast to 0.8 per cent from 0.7 per cent, and to 2.0 per cent from 1.8 per cent for 2013.

Will that be possible? UK inflation hit 15-month lows of 3.4 per cent year-on-year in February, on track to meet the Bank of England’s (BoE) projections required to attain the 2.0 per cent target. This, in turn, paves the way for further monetary easing ahead. As the BoE’s third round of asset purchases is deployed in the next quarter, mortgage approvals could remain near their two-year highs, housing prices regain their ascent and bond yields be suppressed as their supply diminishes. The BoE’s ability to maintain quantitative easing while inflation remains on the decline is a vital luxury. As global bond yields rise in tandem (due to improved growth in the US, better prospects for Eurozone stabilisation and diminishing risks of a Chinese hard landing), it is crucial for BoE purchases to keep a lid on long-term borrowing costs.

About four months ago, France engaged in a war of words with the UK over who deserves its top-notch rating the most. The UK’s deficit stands at 7 per cent of GDP compared to France’s 4.6 per cent. Taking debt by itself, French debt stands at 83 per cent versus 76 per cent for Britain. The comparisons could go on. But one key factor is that the UK enjoys greater monetary freedom than any Eurozone member via currency policy (the ability to talk down the pound via the BoE’s inflation and growth pronouncements), monetary policy (stepping up asset purchase programs to reduce the supply of outstanding gilts and reduce borrowing costs) and the fact it is unburdened by contributing into the European Financial Stability Facility or upcoming European Stability Mechanism).

The 2012 Budget has the necessary components to maintain the UK’s top-notch credit rating. Getting the main agencies to remove their negative outlook would also be possible once the growth assumptions are likely to stick even beyond the temporary windfall of this summer’s Olympics.