The UK market reacted with a mix of relief and caution following the Rachel Reeves’ first Labour Budget in 14 years last Wednesday. The Chancellor introduced a range of fiscal changes that could impact upon future investment strategies across various sectors. Mid-cap stocks and shares on the Alternative Investment Market (AIM) responded favourably with the AIM All Share Index initially climbing 4.4% following the decision to halve inheritance tax relief on qualifying shares, rather than eliminate it outright. This adjustment alleviated fears of more stringent tax implications which have been weighing heavily on the AIM market over recent months. Overall sentiment towards UK smaller companies may remain fragile however, after a period of sustained high interest rates and a heightened aversion to riskier assets. The partial removal of business relief will possibly reduce one of the main drivers for investors to allocate capital to smaller companies.
In contrast, the FTSE 100, which represents the largest companies by market capitalisation in the UK, experienced a decline of 0.6% immediately after the Budget speech, reflecting the more cautious sentiment among investors in established companies. This decline, coupled with a 0.2% weakening of sterling against the US dollar, indicates an underlying uncertainty about the immediate economic outlook.
The bond market experienced a notable but contained reaction, with the 10-year gilt yield initially dipping to 4.23% before rising to 4.40% as investors analysed the report from the Office for Budget Responsibility (OBR). The overall response of the bond market remained muted compared to the extremely negative reaction to the Liz Truss mini-Budget of 2022. Reeves’ proactive communication, her commitment to meeting fiscal rules ahead of schedule and the broadly supportive OBR forecasts indicating a reduction in net financial debt as a percentage of GDP by 2027-28 helped alleviate investor concerns, while her strategy to tighten fiscal rules over a shorter period further bolstered market confidence. Sentiment in the government bond market does though remain cautious.
Commentators are divided on the Budget’s potential to stimulate economic growth with the OBR forecasts being considered overly optimistic by some, compared to those of the Bank of England. While the outcome of the Budget was less severe than anticipated, limited provisions to stimulate robust growth including compelling incentives for investment, may restrain markets. One area for optimism however could be the Chancellor’s intention to implement substantial investment initiatives through the proposed £100 billion in capital spending over the next five years. This could provide stimulus for various sectors, particularly healthcare and education.
While the mixed market reaction and initial rally in mid-cap and AIM stocks reflected relief that the Budget was possibly more benign than anticipated in some quarters, underlying economic concerns, rising gilt yields and a weakened pound have left us with a number of concerns, whilst the longer-term implications are digested. The ‘big hit’ on employers, particularly the impact of higher national insurance has been seen as a major negative that could have a profound impact in reducing growth in the future.
The 2024 Budget presents a combination of challenges and opportunities for investors in the UK. A strategic approach that considers sector-specific issues and tax implications will be important as the outlook evolves, the decision to significantly increase taxes, spending and borrowing being a major shift with no certainty of positive results for public services and importantly economic growth.
