Investment Line: What the budget means for UK shares

Well gilt investors bloomin’ well ought to be happy with this budget.

Of course it does not work like that with government bond investors. It is their job to find something to complain about - as one of Britain's leading gilt investors Ian Williams successfully does in a video on our site today. The first retort to a budget that radically cuts the deficit will be that too many tough decisions have been delayed until the spending review in the Autumn.

Nonetheless, the chancellor George Osborne has shown himself willing to sacrifice economic growth in order to finance the government deficit at around the 3.5% to 4.5% level that could realistically be hoped for over the medium-term.

What about equity investors though? Yesterday saw the market falling, largely on US economic data, but showing little sign of taking comfort from the budget.

This despite the fact that specific sectors like utilities have been spared new taxes and the new bank levy on liabilities has if anything proved less severe than some had feared.

However, the big picture remains that equities tend to struggle during strong fiscal squeezes according to some. Capital Economics's John Higgins robustly claims that it will contribute to a tough next six months to the FTSE 100 – predicting it will end the year at around 5,050 points.

Part of Higgins’ fears revolve around the risk that the Office of Budget Responsibility’s prediction that economic growth next year should be downgraded from 2.6% to 2.3% because of this budget is too optimistic.

Higgins said: ‘Economic growth is likely to be disappointing, if not disastrous. We expect GDP to expand by 1.5% next year, which is significantly less than the 2.3% now projected by the Office of Budget Responsibility. Of course if the scale of the fiscal tightening assuages concerns about the economy’s health, it could have a positive effect on long-term growth and earnings expectations. But that remains to be seen.’

For Higgins an environment where interest rates remain very low constrains the risk-free component of the rate investors are willing to pay for shares. He said: ‘In order to accommodate the fiscal tightening envisaged by the budget. But it is less obvious that investors’ appetite for risk will grow.’

Yet Higgins does not predict that this budget with its affect on growth will send equities into free-fall.

‘We doubt there will be an even bigger drop in the UK stock market in that equities do not appear to be overvalued by historical standards.’ Nonetheless he concludes ‘We do not expect equities are likely to do well any time soon. Gilts should do comparatively better, even if the initial lukewarm reaction of government bonds was rather surprising given the prospect of diminished gilt supply.’

But there is little consensus behind Higgins’ view. Ian Scott from Nomura for example argues that on balance the budget will be good for UK shares.