Investment Commentary – March 2023

P1's CIO reviews the economic data shaping the investment markets and starts to probe where the Chancellor may take the Spring Budget.

2 minute read

Following a strong run since October 2022, equity markets moderated in February. While inflation continues to decelerate and central banks soften their forward guidance, the short term strength of the labour market and concerns of an upcoming recession have dampened investor optimism. There have been some signs of softening labour demand, although in absolute terms conditions remain tight. This has led market participants to anticipate that central banks will have to go further in the short term to suppress economies and create slack. Resultingly, bond yields have crept higher impacting the valuation of all assets.

Domestically, following a year of headwinds, government finances have received a fillip in recent months. This should give the Chancellor some flexibility when preparing the statement and any policy changes for the Spring Budget on 15th March. There were two major shocks to the government finances in 2022, energy prices and inflation. These had a direct impact on government spending with price subsidies for domestic and business energy use and higher interest costs coming from inflation linked government bonds. Both of these, as well as numerous second round effects are likely to reverse over the coming months. Indeed, energy prices are already at a level where the need for government subsidy has almost disappeared, with the redundancy of the energy price guarantee predicted in July. The total cost of the scheme is likely to be 90% lower than originally predicted, saving the government 10’s of billions of pounds.

While inflation remains high, anticipation of the headline figure falling in the short term will give the government some confidence to walk back some of its previous reluctance to stimulate demand and loosen purse strings. Recent developments in industrial relations suggest that the situation is improving, and that there may be some greater flexibility on offer by the government. There will also be calls for some of any windfall to be allocated to reversals in the recent tax increases. With corporation tax due to be increased to 25% and freezes in personal tax thresholds, there has been an increase in the tax burden on companies and individuals alike. These political choices are likely to be revealed over the coming weeks as we approach the day of the budget.

More broadly, the global economy is attempting to conduct a “soft landing” following the COVID reopening boom period. Many developed markets have experienced similar difficulties to the UK, particularly European ones, where energy prices have had a significant impact. However, over the coming year, the reopening of the Chinese economy may confuse this picture. While China experienced the first cases of COVID and the first lockdowns, it was the only major market to persist with these as a control measure until late in 2022. Currently, the Chinese economy is experiencing its own reopening boom, increasing demand for commodities and goods, whilst increasing manufacturing supply and lessening supply chain disruption too. Given these positive and negative effects, markets may find it difficult to interpret data and volatility is likely to remain high.