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    Preview: UK Summer Budget 2015

    Wednesday’s emergency Budget comes on the back of the Conservative Party’s victory in May’s election. Although events in Greece are stealing the limelight, we still think that this week’s Budget has the potential to cause volatility in GBP markets.

    The backdrop:

    The Conservatives have been fairly transparent about their desire to eliminate the budget deficit by the 2018/19 fiscal year, and most of the plans for spending cuts have already been leaked to the press. The Office for Budget Responsibility has forecast that spending cuts over the next two years will be twice as deep as any annual cut in the last parliament. The biggest cuts will come from the welfare budget where GBP 12 bn will be saved. However, other departments including police and education are also concerned about how cuts will impact job numbers along with their services.

    Will this Budget hurt the UK economy?

    Estimates suggest that 100,000 civil service jobs could be cut during this parliament, on top of the near 90,000 jobs lost during the last parliament, however, in recent years the private sector has picked up this slack. Already there have been warnings that growth could suffer as a result of decisions announced during this Budget, so to cushion some of the blow, Osborne has already announced some sweeteners including a change to inheritance tax law.

    Typically the first Budget after an election can be see a Chancellor sneak in some tax increases, however he has promised not to increase income tax or corporation tax this year. Thus, watch out for stealth tax increases instead. We also expect a few surprise sweeteners, especially as GBP 5 bn is expected to be shaved off the budget deficit for this year on the back of a pick-up in tax revenues.

    To make things as simple as possible, below we take a look at 4 things that we will be watching out for and what this could mean for the pound and UK stock markets:

    City Index Budget watch list:

    • Banks: There is a chance that the banking levy could be lowered, or even scrapped completely. The levy was designed to make large banks safer and arguably capital ratios have already improved. We think that there is a greater chance of the levy being lowered rather than scrapped completely. If this happens then it could benefit HSBC and Standard Chartered, two banks with large foreign exposure who were particularly impacted by this levy. If Osborne confirms that the levy is to be scrapped then we would expect UK banking shares to soar. In particular HSBC, its share price has been under intense downward pressure since April. Between April and July this year HSBC’s share price is down close to 20%, bringing the year-to-date loss to 8%, so there is room for some upside appreciation if the Budget delivers good news. But if the Chancellor doesn’t change the levy then bank stocks could come under pressure, which may weigh on the FTSE 100, since banks make up approx. 14% of the entire index.
    • Homebuilders: If the Chancellor announces an overhaul to council tax then this could impact parts of the construction sector. Currently council tax is based on 1991 valuations, if valuations are updated to reflect the boom in house prices, particularly in the South East, then we could see the cost of council tax rise for thousands of people. This could reduce the affordability of housing, particularly in the mid-section of the housing market, which could weigh on the share prices of UK homebuilders including Barrett’s, which is the biggest homebuilder by market cap. It’s share price has risen by 35% so far this year and easily outperformed the overall FTSE 100. If a change to council tax is confirmed then its share price may be easy prey for the bears.
    • Sterling negative: If the Office for Budget Responsibility revises down the growth forecast for the next few years on the back of the spending cuts, or expresses doubt that the government can reach its deficit targets during this parliament, then we could see the pound struggle, particularly against the USD.
    • Sterling positive: If Osborne announces any measures to boost the manufacturing sector then it may limit GBP downside, particularly after weak manufacturing production caused a sharp drop in GBPUSD on Tuesday.

    Overall, this emergency Budget may not have the glamour of the Greek crisis for the financial press, but George Osborne has the power to throw in a few surprises that could rattle financial markets, so it is definitely worth watching at 1230 BST.

    The technical view:

    GBPUSD: We expect the pound to be in focus on Wednesday. As we mention above, the pound had a torrid day on Tuesday. In the last 24 hours the pound has faltered against all of its G10 peers apart from the Norwegian krone. GBPJPY has been the worst performer, although this is mostly down to risk aversion caused by Greece. GBPUSD has also tumbled more than 1% so far this week. It managed to find a critical support level around the 200-day sma at 1.5425. This leaves GBPUSD in an interesting position as we lead up to the Budget. If the market likes what it hears from Osborne then GBPUSD could recoup some losses, which may reinforce the 200-day sma as short term low. However, if we fall through this level then we could see a decline back to 1.5273 – the 100-day sma, ahead of the May 5th low at 1.5089.

    EURGBP: this pair has been in consolidation mode post the Greek referendum result on Sunday, we continue to think that this pair is vulnerable to further downside, however, we think the bigger driver for this pair is European events, not the UK summer Budget. 0.7000 is a massive level of support, if Osborne’s Budget is considered GBP-friendly then we may test the air below this critical level.


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