UK public sector borrowing slows, as tax cut hopes grow, the BOJ and China in focus

The pound popped higher on Tuesday morning after the UK’s public sector borrowing figure for December was released. The market was expecting borrowing to come in at £11.2bn, when it was actually significantly lower at £7.7bn. This is the lowest December figure since 2019. Net debt rose from 97.4% of GDP in November 2023 to 97.7% of GDP in December 2023, as the UK edges towards the 100% of GDP milestone, which it is set to hit at some stage this year. The slowing pace of borrowing at the end of last year comes at an opportune time for the Chancellor, who has already flagged tax cuts as the centre piece of his March 6^th Budget.

The driver of the decline in borrowing was the fall in inflation-linked debt interest costs. The large amount of inflation linked debt issued by the UK government was treacherous for the UK’s fiscal position when inflation was surging, but now that inflation growth is falling it is shedding a flattering light on the UK’s borrowing. However, the government still needs to be confident that the inflation genie is firmly back in the bottle before they go on a tax cutting splurge on March 6, and it’s also worth noting that inflation remains above the BOE’s 2% target rate.

The market reaction to public debt figures can be difficult to gauge. When figures are worse than expected it can weigh on UK asset prices, especially the pound. Although the data was better than expected for December, net debt is still rising so it’s hard to see how this is good news for the pound. However, GBP/USD has popped higher on the back of this data, and is currently trading around the £1.2740 level, after having a decent increase of 0.8% over the last 5 days.

The prospect of a spring budget giveaway increases

This data supports tax cuts in the Spring budget. Revenue was buoyant, after falling slightly in November and although the deficit was 10% higher than a year ago, largely driven by an increase in public sector wages, it was £119.1bn, which is lower than the OBR forecast of £124.1bn. This ‘good news’ comes ahead of January’s data which is released next month and is usually a bumper month for tax revenue.

The Office for Budget Responsibility’s commentary on public sector finances is released later today. It is worth noting that Tuesday’s actual borrowing data was approximately half the level expected by the Office for Budget Responsibility for December, so we expect this to be noted in the OBR bulletin. We will also get useful insight, which may help to predict just how much headroom the Chancellor will have to cut taxes in March. Some reports believe it could be as much as £19bn, which would facilitate a hefty income tax cut along with funding the childcare scheme. Either way, the pickup in the UK’s public sector finances comes at an opportune time for the government as they try to sweet talk voters ahead of the upcoming general election.

Do tax cuts actually boost growth?

However, while tax cuts could be cheered by the market, the Treasury believes that increasing high-skilled migration along with changing planning rules to build more homes would have a high impact on the economy with a low fiscal cost. A personal tax cut would have a low impact on the economy. The memo from the Treasury to the Prime Minister was sent in 2022, but it is relevant today, as the UK’s economy is set to remain lumbered with slow growth for the foreseeable future.  

China to sell foreign assets to prop up its stock market

Asian stocks were broadly higher on Tuesday and China’s stocks managed to claw back some recent losses, after the Chinese authorities were reported to be considering a support package of $278bn. This could see offshore accounts of Chinese state-owned enterprises buying shares onshore through the Hang Seng. There is also talk of onshore funds buying up to RMB300bn of domestic shares. This has helped the main Chinese index to rally by more than 1.5% so far on Tuesday and the Hang Seng has bounced back by 2.6%.

At this stage, we don’t know any further details, for example, which accounts will buy on shore shares, and will they need to divest foreign shares or other foreign assets to do so? While the global financial market could absorb $270bn of selling pressure from China, if they pulled that amount of money out at once it could dent risk sentiment and impact movements in financial markets. It is worth noting that the current size of this fund is dwarfed by the $6 trillion that has been wiped off of Chinese and Hong Kong shares since their peak in 2021. Thus, it could take much more than this package to stabilize the Chinese share market in the long term. It is also useless trying to speculate what this means for European or US stock and bond markets, instead, it is a warning sign that China is willing to use its vast amount of foreign assets to prop up its own stock market in its time of need. Investors and traders need to take note.

Bank of Japan on pause for now, but ready to strike in April

Elsewhere, the yen is higher vs. the USD on Tuesday after the Bank of Japan kept interest rates on hold at -0.1%. The BOJ governor said that he would raise interest rates when Japan’s price goal comes into view. However, he also added that the certainty of the outlook – i.e., that the price goal will be reached – is rising. There appears to be a change in tone from the BOJ, which has pushed the chance of an April rate hike to 50%. This could keep upward pressure on 10-year Japanese government bond yields, which have fallen in recent weeks and dropped by another basis point on the back of this meeting. The focus is now on the spring wage negotiations and how these could impact inflation in the medium term.

A Trump nomination is nearly on the cards

In the US, we could get a better idea if Donald Trump will win the Republican nomination later tonight, when the New Hampshire Primary will be called. Polling suggests that this is Trump’s to lose. New Hampshire was the state where Nikki Haley had the best chance to beat Trump, yet she can’t seem to catch up at this late stage. If Haley loses in New Hampshire, as seems likely, it will be interesting to see if she stays in the race or if she pulls out. If she chooses the latter option, then a Trump/ Biden Presidential race is a near certainty. The market reaction to a Trump win in New Hampshire is worth watching. It could increase volatility on bond yields as the Treasury market tries to price in the risk of extra protectionism and uncertainty in economic policy under another Trump presidency. This could also limit the stock market rally, after the S&P 500 made another record high on Monday.