Inside the Red Briefcase

Editors’ Note: MarketMinder Europe prefers no political party nor any politician. We assess developments for their potential economic and market impact only.

At last, after a weeks-long international guessing game, Chancellor of the Exchequer Rachel Reeves has stepped out of 11 Downing Street with the customary red box and revealed its contents: An estimated £70 billion in new annual spending, £40 billion in new taxes and £32 billion in extra annual borrowing.^[i] Throughout the commentary we reviewed Wednesday and Thursday, we saw many and varied takes—most of which we would describe as largely sociological, focussed on matters our research shows don’t affect stocks materially over time. Whilst markets have been rocky since the announcement, we think this should pass quickly. For investors, we think there is a very simple takeaway: Uncertainty, which appeared elevated as the government floated numerous policy trial balloons, is at last set to start dropping. Whatever your opinion of the new fiscal measures, we think stocks are likely to benefit from simply having clarity, not to mention the tax hikes being smaller than many commentators we follow warned was likely.

First, let us address the immediate market volatility, which commentators we follow globally zeroed in on. With 10-year Gilt yields up on Wednesday and Thursday, many commentators we follow argued markets are reacting negatively to the budget’s debt increase, arguing it raises market risk.^[ii]

On the surface, it seems logical. Our research finds bond markets move on supply and demand, and yields move opposite prices. So a planned supply increase, all else constant, should make prices fall and yields rise. However, looking only at Gilt yields strikes us as incomplete. To us, the relevant question isn’t just what Gilt yields did, but what they did relative to other countries. French yields also rose Wednesday and Thursday.^[iii] Were investors in French debt freaking out over higher UK borrowing? What about US Treasury yields, which rose Wednesday and Thursday morning before drifting back lower?^[iv] Did Uncle Sam’s creditors panic over UK debt when they woke up? What about German, Italian and Spanish yields?^[v] Could it be that bond markets are simply global and volatile, and fiscal policy changes in one country aren’t the major driver many commentators claimed Thursday?

We can do the same exercise with stock markets. UK stocks dropped Wednesday, but so did US markets and those across Europe.^[vi] When both are denominated in US dollars to eliminate currency skew, British and US stocks fell -1.91% and -1.86%, respectively.^[vii] UK stocks fell a little bit further in dollar terms, but the difference literally rounds to nothingness! When both are denominated in pounds, UK stocks fell less.^[viii] When you view UK market movement in a global context, we think it starts looking less like a knee-jerk Budget reaction and more like a global, sentiment-driven hiccup.

Zooming out from this very short-term move, UK stocks entered Wednesday pretty much flat since July’s election.^[ix] We wouldn’t read much in this, either, as European stocks are also flattish. But we haven’t seen the rally we would generally deem likely to stem from falling political uncertainty.^[x] Why is harder to discern than what, but we think the fiscal policy guessing game is a likely culprit. Let us explain.

Since the campaign, Reeves and Prime Minister Keir Starmer have signalled taxes would rise. It wasn’t a flagship campaign pledge—VOTE FOR US AND WE WILL RAISE YOUR TAXES isn’t exactly a winning banner—but it seemed implicit. They pledged to raise public investment, spending and wages, and they paid lip service to requisite deficit reduction. Given the money for new spending and investment would have to come from somewhere, higher taxes seemed a foregone conclusion.

But society didn’t know which taxes would rise or how much. Campaign materials pledged not to raise taxes on “working people,” which meant not raising VAT, national insurance contributions or income tax rates (presumably on the lower income bands).^[xi] This left capital gains taxes, property stamp duty, inheritance taxes, carried interest and other avenues as targets, but this process of elimination didn’t add clarity. For one, Starmer and other government ministers didn’t define “working people” when pressed, and several outlets we follow noted workaday folks tend to own stocks and might have scratched and saved to invest in a buy-to-let property to supplement their income.^[xii] So questions abounded.

Adding to the confusion, the government seemingly floated several tax proposals via unnamed sources briefing journalists. This is a time-honoured tradition reportedly practised by both Tory and Labour governments: To test the waters, they leak an idea and see how markets and analysts react. If the feedback isn’t good, they can tweak and water down as needed. And if it is good, they can pencil it in and move on. We concede it is a fine political trick, but the sheer volume of leaked ideas seemingly raised more questions than it answered this time. It amped up headline chatter and debate over what the possible moves could mean.

In general, we find stocks don’t like this sort of uncertainty. When people don’t know what future taxes will be, it makes planning difficult. Based on our observations, businesses and investors tend to enter wait-and-see mode, unwilling to take risk until they have more answers. We saw a lot of anecdotal evidence of this in the UK, based on a number of articles we read. We also read numerous reports of people trying to front-run changes, whether by selling UK stock funds, dumping buy-to-let properties or taking lump-sum pension distributions early, all to lock in lower rates ahead of potential changes. Across the country, risk aversion appeared to be up.

But we also find higher uncertainty eventually has a happy flipside: falling uncertainty. In this case, we don’t think it is limited to businesses and individual investors now knowing what they are dealing with. It also happens that the new taxes aren’t as onerous as several commentators we follow warned they would be. This is just one market driver, but our research finds markets tend to benefit when tax policy gets watered down from initial projections.

For example, for months, headlines have warned Reeves could scrap preferential capital gains tax rates, instead equalising them with income tax rates. That would have taken rates from 10% and 20%, depending on whether the individual pays the Basic or Higher Rate of income tax, to 20%, 40% and 45%. Some warned these high rates would apply to realised gains on all assets, including second homes, buy-to-let properties and privately held businesses.

But the actual increase wasn’t so large. The lower rate will rise from 10% to 18%, with the higher rate rising from 20% to 24%.^[xiii] The rate on the sale of second homes will stay at 18% or 24%, depending on the seller’s income.^[xiv] Business and agricultural asset sales less than £1 million will be tax-free, and a 20% rate will apply above this.^[xv] So yes, rates will rise, but nowhere near to the degree many commentators deemed likely. This is the kind of relief we find stocks generally welcome.

The remaining tax hikes are what one could call stealthier. As previously signalled, Reeves extended the prior government’s income tax band freeze until fiscal 2028/2029, which will drag more income into higher brackets as inflation continues lifting wages and salaries—a well-known, long-running stealth tax hike.^[xvi] Whilst employees’ national insurance contributions won’t rise, employers’ contributions will jump from 13.8% to 15.0% next April. Smaller businesses will benefit from a higher allowance, but larger firms’ allowance will drop. Oh, and with the minimum wage set to rise 6.7% next April, the employer national insurance tax base is about to jump—albeit temporarily, as the Office for Budget Responsibility (OBR) projects the higher wage and payroll tax will reduce hiring.^[xvii]

Elsewhere, the tax rate on carried interest, which primarily affects hedge and private-equity fund managers, will rise from 28% to just 32%, still well below the Higher and Additional Rate of income tax.^[xviii] Seemingly surprising no one, the oil windfall profits tax will rise from 35% to 38% and will sunset in March 2030 instead of March 2029.^[xix] And the non-domicile resident tax status will cease to exist in April, ending preferential treatment for wealthy ex-pats residing in the UK.^[xx] Please note that this is not a comprehensive list—these are just what we consider the highlights.

Other taxes will actually fall. Pubgoers will enjoy a slight reduction in the duty on draught beer (which prompted several lists featuring the best cask ales to try), whilst brick-and-mortar retail, hospitality and leisure businesses will see lower business rates from fiscal 2026/2027. We reckon many shop owners will hoist a slightly cheaper pint to this news, benefitting doubly.

As for the spending side, we noted minimal surprises. Most of the increase will go to public services and wages, which the government has long telegraphed. Reeves also earmarked £1 billion for investment in aerospace, £2 billion for electric vehicles and £500 million for life sciences, plus £20.4 billion in research and development spending next year.^[xxi] And to manage this under the official fiscal constraints, Reeves confirmed the official debt measure will become public sector net financial liabilities, which offsets debt partially with investments. This procedural change attracted much discussion on econo-Twitter and such, but we think it changes little in the real world—in our opinion, UK debt was already in fine shape, as we showed this summer.

The OBR’s official scoring projected this Budget will have minimal effect on GDP growth over the next five years.^[xxii] It estimates a small short-term boost from higher spending, but in the medium term it sees the higher tax burden counterbalancing higher spending. We think that is a logical take, but we always recommend taking these forecasts with many grains of salt. They use a host of assumptions and straight-line math and can’t account for actual real-world developments. Plus, in this globalised world, we think UK growth is less dependent on local public spending and tax rates than on how the entire global economy is doing. Our research finds global growth has pulled many a high-tax nation along in the past, and their taxes were a lot higher than what the UK is about to swallow.

Overall, we don’t see anything here as likely to be make or break for the UK’s economy or markets. The measures create winners and losers, as we find all fiscal policy changes do, but none of the losers strike us as huge or unexpected. That simple reality alone looks likely to enable markets to move on over time, recent short-term volatility notwithstanding. Politics is just one factor affecting UK stocks—the country’s sector concentrations have a large bearing on returns, too—but fiscal clarity should be a modest tailwind.