Credit Agencies to Remain at Bay for Now

The UK Budget has the basic requirements to keep credit agencies at bay… for now. The plan is to enact a 7% stamp duty on property worth more than £2m, slashing the main corporate tax to 24%, lifting the personal allowance by £1,100 to £9205, and announcing the much-telegraphed reduction in the top tax rate from 50% to 45%. 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 £126 bn, 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 autumn for over the next five years and 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% from 0.7%, and to 2.0% from 1.8% for 2013. It also predicted the unemployment would peak at a lower level of £1.67m this year.

Will that be possible? UK inflation hit 15-month lows of 3.4% y/y in February, on track to meet the Bank of England’s projections required to attain the 2.0% target. This, in turn paves the way for further monetary easing ahead as pound strength helps absorb external inflationary pressures. As the BoE’s third round of asset purchases is deployed in next quarter, mortgage approvals could remain near their two-year highs, housing prices regain their ascent and bond yields are suppressed as their supply diminishes. The BoE’s ability to maintain QE while inflation remains on the decline is a vital luxury into the rest of the year. As global bond yields rise in tandem (due to improved growth in the US, better prospects for eurozone stabilization 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. UK’s deficit stands at 7% of GDP compared to France’s 4.6%. Taking debt by itself, French debt stands at 83% vs. 76% for Britain. Yet, when including maturing bonds and interest cost, France owes £100bn his year, compared to half that amount by the UK. The comparisons could go on. But one key reminder is that he UK the enjoys greater monetary economy than any Eurozone member via currency policy (ability to talk down the pound via BoE’s inflation & growth pronouncements), monetary policy (stepping up asset purchases programs to reduce supply of outstanding gilts and reduce borrowing costs) and European policy (unburdened by contributing into the European Financial Stability Facility or upcoming European Stability Mechanism).

The 2012 Budget has the necessary components (and assumptions) to maintain the UK 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 summers Olympics.