Speculation over increases to capital gains tax and the top rate of income tax is set to intensify, with investors expected to adjust portfolios.
Susannah Streeter, Chief Investment Strategist, Wealth Club: “The Footsie has been on the back foot in early trade as investors keep an eye on Middle East tensions, a stronger pound puts pressure on some listed multinationals, and investors assess the Burnham administration’s policies. A slightly more resilient snapshot of the UK labour market has lifted sterling, just as the Prime Minister unveiled the first significant cost-of-living intervention of his premiership. The abolition of VAT on household electricity bills from October should provide some welcome relief for households, although it will only make a modest dent in overall energy costs, amounting to around £45 per year for a typical bill payer. Investors will now be looking beyond the immediate announcement to how further support measures can be funded while keeping the public finances on a sustainable footing.
The latest snapshot of the UK labour market highlights the difficult inheritance facing the new government. While unemployment has edged slightly lower compared with the previous quarter, suggesting employers are hanging on to staff, the rise in the claimant count underlines that many families continue to feel the squeeze. Employment has largely stalled and economic inactivity remains stubbornly elevated, pointing to an economy that's proving a little more resilient than expected but still sluggish. Sterling has nudged higher, an indication that investors are increasingly pricing in two further interest rate hikes from the Bank of England after figures showed the jobs market is holding up better than forecast.
That resilience, however, comes with a sting in the tail for the Burnham administration. If borrowing costs stay higher for longer, it will make the task of repairing the public finances while delivering further cost-of-living support even more difficult. Cutting VAT on electricity bills is a relatively inexpensive intervention compared with lifting the threshold for the first rate of income tax, but if the government wants to go further it will have to find room within already tight fiscal constraints and raise money elsewhere. Burnham's government will also need to find ways to lift productivity and coax more people back into the workforce if it wants to generate the stronger economic growth needed to relieve pressure on households and the Treasury alike.
A little more hope appears to be creeping in about the potential for negotiations to resume in the Middle East and act as a circuit breaker to escalating violence. Amid rumours that talks could restart this week, Brent crude has shifted a little lower to around $88 a barrel, and some optimism has returned to financial markets. Stocks in Asia largely lifted, with Japan's Nikkei clawing back some of its losses. But as investors assess the shifting expectations about where the conflict could go next, European indices look set for a flat start to trading.
Fractious trade policy is once again front and centre, with the US slapping 50% tariffs on some Canadian goods, underlining how brinkmanship remains a key feature of the presidency. The higher duties are set to be imposed within 30 days, in retaliation for what Trump claims is unequal treatment of US cars, dairy and alcohol. Futures markets indicate that Toronto's main exchange will open in the red, as investors react to this fresh deterioration in bilateral relations. But Prime Minister Mark Carney appears sanguine, deflecting the threats with a vow to intensify negotiations. There will be expectations that the US will roll back after some concessions are made, but it's a reminder of the Trump administration's bullish treatment of both former friends and long-time foes.
There's been a cautious welcome on markets to John Healey's appointment as Chancellor, taking control of the UK's fragile finances. Former Defence Secretary John Healey was a Treasury minister in Gordon Brown's government, and there's an expectation he'll very much be playing second fiddle to Andy Burnham when it comes to leading economic policy, singing from the same song sheet on decentralisation and backing regional industrial bases. But the immediate focus will be on the military implications of his appointment. Having resigned from government over the lack of a roadmap to meet NATO commitments of defence spending reaching 3% of GDP by 2030, attention will now turn to how quickly he might be able to find more funding to bolster the defence investment plan. Shares in military contractors BAE Systems, Rolls Royce, QinetiQ and Melrose were all higher in early trade, indicating investors expect the chancellor will be a bigger backer of defence than his predecessor. There will be cautious optimism to his appointment across the armed services. Having spent months making the case for higher military spending, Healey has a detailed understanding of the capability gaps facing the armed forces and the demands of a far more dangerous geopolitical environment. It comes at a highly timely moment, given reports of live-firing weapons exercises by a Russian warship off the Plymouth coast. The service chiefs are likely to believe they now have a Chancellor who understands their concerns more fully and may be more willing than his predecessor to set out a credible pathway towards spending 3% of GDP on defence.
However, he's also inherited responsibility for balancing the nation's books, and the question will be whether he can reconcile his long-standing support for higher military spending with the government's fiscal rules, which require debt to be falling as a share of the economy by the end of the Parliament. Finding room for defence while also funding infrastructure, social care, employment programmes and measures to boost growth could prove one of the defining challenges of his time at the Treasury.
It also puts the question of tax rises back front and centre to fund these demanding requirements, especially with the VAT cut to energy bills, with speculation about increases in capital gains tax and further changes to the top rate of income tax likely to intensify. However, investors should resist the urge to drastically alter portfolios in an attempt to get ahead of potential tax changes. History shows us that rashly switching and ditching assets based on speculation can lead to unnecessary transaction costs, trigger premature tax liabilities and, crucially, miss out on the power of long-term compounding. Timing the market is hugely difficult, and time in the market is what counts most. Nevertheless, it may be worth trimming positions which have performed spectacularly well to lock in gains. For those looking to shelter their portfolios, it is well worth exploring government-backed, tax-efficient life rafts like Venture Capital Trusts (VCTs), the Enterprise Investment Scheme (EIS), and the Seed Enterprise Investment Scheme (SEIS).”
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