Prepare for the UK Autumn Budget: Top Insights and 3 Must-Consider Investment Strategies

What is the Autumn Budget and Why is it Important?

The Autumn Budget, to be delivered by Chancellor Rachel Reeves on October 30, is the Labour Government's first budget in nearly 15 years. It's a crucial moment because the government faces a significant £40 billion budget gap, known as a 'fiscal hole,' which it needs to address. This budget will outline how the government plans to raise money through taxes and spend on public services like healthcare, education, and infrastructure. It's important because the decisions made in this budget will affect the UK’s economy, public services, and how much the government borrows.

How Higher Borrowing and Taxes Will Resolve the Fiscal Gap

To close the £40 billion fiscal gap, the government is expected to use higher borrowing and higher taxes. Here’s how it works:

1. Higher Borrowing:

- The government will borrow money by issuing bonds (gilts) to cover immediate spending needs, particularly for large investments in infrastructure or public services. This helps in the short term, allowing the government to improve services without cutting too deeply into current programs.

- Although borrowing increases debt, careful borrowing for productive investments can boost the economy in the long run, helping to generate more tax revenue in the future.

2. Higher Taxes:

- The government is likely to raise taxes, particularly focusing on wealthier individuals and corporations, rather than workers. These tax hikes will provide more revenue to cover day-to-day government expenses like healthcare, pensions, and education.

-  Increasing taxes on areas like capital gains, inheritance, and corporate profits will help reduce the deficit while protecting working people from income tax increases.

What the Markets Need from the Autumn Budget

For markets to have confidence in the government, the Autumn Budget needs to reflect a clear and balanced approach to managing public debt, spending efficiently, and stimulating growth. Investors and financial markets will be looking for:

1. Responsible borrowing: The government must show it can borrow money without causing alarm, ensuring debt remains manageable.
2. Clear fiscal rules: Setting rules around how much the government can spend and borrow over time will reassure markets that the UK won’t face sudden financial instability.
3. Investment in growth: Markets will be more confident if the budget includes spending on projects that boost long-term economic growth, like infrastructure, healthcare, or education reforms.

Implications of the Autumn Budget for the Bank of England

For the BoE, the Autumn Budget presents a mixed picture. While fiscal easing is moderate, the large increase in gilt issuance and higher borrowing could create upward pressure on bond yields and complicate the BoE's quantitative tightening plans. Additionally, the potential for fiscal-driven inflation could temper the BoE's ability to aggressively cut rates in the coming months, requiring careful navigation of monetary policy in response to fiscal changes. The implication of the Autumn Budget for policymakers are the following:

• Increased Borrowing and Gilt Issuance. More gilt issuance will push yields higher, affecting bond prices. The BoE may adjust its quantitative tightening (QT) to manage market stability.
• Modest Fiscal Easing and Inflation. Fiscal easing could drive inflation, complicating BoE rate cuts. Persistent inflation means higher borrowing costs for longer, impacting rate-sensitive sectors.
• Debt Sustainability and Market Confidence. Rising debt-to-GDP ratios may lead to higher risk premiums on UK assets. The BoE’s response could affect bond yields and the pound.
• Public Investment and Growth.  Increased public investment could boost growth in sectors like infrastructure. However, if it stokes inflation, the BoE may keep rates high.

Three  investment strategies to consider ahead of the UK Autumn Budget:

1. Infrastructure Investments.

The UK Autumn Budget is expected to prioritize infrastructure spending, particularly in housing, construction, and large public projects. With interest rates expected to fall, financing for these projects becomes more affordable, creating attractive opportunities in the infrastructure sector. Government initiatives, such as easing planning regulations and promoting public-private partnerships, will further boost growth in infrastructure investments, including civil engineering and construction.

How to get exposure to UK Infrastructure through ETFs?

1. iShares UK Property UCITS ETF (IUKP). This ETF provides exposure to UK real estate companies, including those involved in property development, which is closely tied to infrastructure growth.

2.  UK Equities and Pension Fund Demand. 

While there may be some risks related to changes in pension tax relief or tax-free cash, the overarching theme of increased investment in UK markets is likely to benefit UK-listed companies, particularly those that are already popular with institutional investors.

How to get exposure to UK Equities through ETFs?

1. iShares MSCI UK IMI UCITS ETF (IUKD). Offers diversified exposure to UK equities, including large, mid, and small-cap companies. It covers a broad range of sectors that could benefit from increased pension fund allocations.

2. Vanguard FTSE 100 UCITS ETF (VUKE). Provides exposure to the largest 100 companies listed on the London Stock Exchange. These companies are likely to attract institutional investment if pension funds increase their UK market allocations.

3. SPDR FTSE UK All Share UCITS ETF (FTAL). Tracks the performance of the FTSE UK All-Share Index, giving broad exposure to UK equities across all sectors, including those that might benefit from pension fund demand.

3.  Bond Markets.

The UK Autumn Budget is expected to result in increased government borrowing, leading to higher gilt issuance. This, combined with potential inflationary pressures from fiscal easing, could result in volatility in gilt yields. As more gilts are issued to finance public spending, yields may rise, negatively impacting the price of longer-dated bonds. Furthermore, any uncertainty regarding debt sustainability or market confidence could exacerbate this volatility.

For investors seeking to limit exposure to interest rate risk and price fluctuations, short-term gilts offer a more stable option. Shorter-duration bonds are less sensitive to changes in interest rates, making them a safer choice in periods of rising yields or market uncertainty. By focusing on short-term gilts, investors can reduce the potential impact of price declines caused by yield volatility.

How to get exposure to short-term Gilts?

1. Shares UK Gilts 0-5 Year UCITS ETF (IGLS). Tracks the performance of UK government bonds with maturities between 0 and 5 years. This ETF offers reduced interest rate sensitivity due to its short duration.

2. Lyxor UK Government Bond 0-5Y DR UCITS ETF (GIL5).  Provides exposure to UK government bonds maturing in the next 0 to 5 years, helping investors manage volatility and limit exposure to long-term interest rate movements.