How Budget measures will affect our business sector

Jun 30 2010 by Andrew Miller, The Journal

LAST week's emergency Budget came in broadly in line with investors' expectations, but on balance we believe that the corporate sector came out of it better than had been feared.

As a result, we think there is still scope for the FTSE to make headway over the remainder of 2010.

One of the most important features of the Budget were the projections for the structural fiscal deficit to fall to 0.8% by the end of this Parliament (2014-2015), which have soothed fears about the sustainability of the UK’s prized AAA credit rating.

The threat to the UK’s AAA status has been one of the macro factors overshadowing the UK market, and we therefore now expect that the FTSE should be able to make up some of its recent underperformance relative to the US S&P 500. In our view, the retention of AAA status is likely to be more important than any trimming of GDP projections.

In terms of the details, the increase in VAT to 20% from January 4, 2011 has made most headlines and is seen as a clear negative for the retail sector. It is not expected that the full increase will be passed on to consumers immediately and it will therefore eat into already-thin margins at a time when the cost of goods sourced from Asia is increasing.

The increase may also hit demand, especially for big-ticket items. However, the increase had been expected – retailers have underperformed for the year to date – and was already partly priced into the market. If anything, the delay in the increase until next year gives retailers some time to adjust and may even provide a short-term boost to demand as consumers try to avoid the increase.

Furthermore, the decision not to widen the scope of VAT to food should be taken as a positive for food retailers. However, we cannot ignore the fact that the corporate sector faces more direct pain. Capital allowances are being reduced significantly; this will hit sectors with high levels of capital expenditure. However, corporation taxes were also cut: the phased reduction from 28% to 24% will make the UK one of the most competitive places to do business in the G20 and should support earnings.

In the financial sector, a bank levy was widely expected, but at an estimated £2bn the headline figure was less than feared. Balance sheet liabilities will be taxed at 0.04% in 2010, rising to 0.07% in 2011. Currently it is unclear exactly how much will be raised by the levy, but our estimates suggest that the hit could be equivalent to 5% of 2012 earnings.

Other Budget measures worthy of mention from an investment standpoint are the freeze to alcohol and tobacco duty. The reversal of the proposed tax increase on cider was also welcomed by the beverages sector. The maintenance of airport duty at pre-budget levels should also be seen as positive for tour operators.

Overall, the corporate sector came out of the Budget a little better than had been expected. Meanwhile, tougher fiscal conditions are likely to mean that interest rates will stay low for longer. The UK’s AAA credit rating is under less threat than before and we expect that the FTSE, with its attractive valuation, can make gains from current levels over the remainder of the year.

Andrew Miller is regional office head of Barclays Wealth in Newcastle