This Budget is all about three things – Brexit, productivity and housing. The first looms over everything like a spectre but do not expect anything overt from the Chancellor.  But on productivity and housing there ought to be some significant policy announcements.

Productivity, wages, inflation

OBR forecasts productivity growth of 1.6% a year over next five years – this would reduce borrowing to £21bn by 2020/21. Yet output per hour has averaged 0.4% a year for last seven years and was actually in decline in first half of 2017. The OBR says it will downgrade productivity growth forecasts based on lessons learned. The IFS says downgrade to 1% would push forecast borrowing up to £33bn by 2020/21 – erasing the headroom from lower borrowing this year.

Recent data is more encouraging. The ONS said productivity improved 0.9% in 3 months to Oct, which was the best since 2011. There is also further good news on jobs with unemployment at record lows – most recent data showed it fell 59k to 1.42m, rate steady at 4.3%, down from 4.8% a year ago

But with inflation at 3%, real wages are still falling. But with the labour market so tight there ought to be some upward pressure on wages – but when? The Bank of England suggests pay growth will accelerate in 2018 – settlements to increase 2.5%-3.5%, from 2%-3% this year. Lack of wage growth does seem to be structural problem – we see it in US too – wages are not rising as fast as the Philips Curve would tell us they should.

Deficit

The Chancellor wants to achieve structural deficit below 2% by 2020/21, which OBR said in March he is still on course to hit.

Borrowing in first half ran at £32.5bn, down £2.5bn from year ago and down £6.1bn from originally forecast and lowest level since financial crisis (2007) – does give some headroom. YTD borrowing is £4.1bn lower at £38.5bn – lowest since 2007. September borrowing declined 11% yoy – to lowest in ten years, but it rose again in October.

The good news for the chancellor is that he is on course for the deficit to be £10bn lower, pushing it nearer to c£48bn than the official OBR forecast of c£58bn. Lower government spending and claims for tax credits have helped.

Borrowing last year (2016/17) is also now believed to be £45.7 billion, £6.4 billion lower than the OBR’s March 2017 forecast, which was largely because income tax, VAT, NI, corporation tax receipts were higher than expected.

However, with the OBR about to revise down productivity growth we expect the headroom/war chest to be significantly reduced. Therefore any significant splurge on additional borrowing – greater gilt issuance – seems unlikely at present. The Chancellor will also bear in mind that he has to keep his powder dry for a possible hard Brexit.

Should Chancellor borrow more?

Against what was expected, Britain has not had to borrow more to offset the impact of Brexit. Risks of a bad Brexit mean the Chancellor will want to keep that up his sleeve for now – and he is not one to abandon his fiscal targets in any event. But perhaps he should be more aggressive.

In terms of gilts, the debt-to-GDP ratio is most important versus absolute borrowing figures (borrowing can be good for growth when it’s targeted) and debt-to-GDP has stabilised and is starting to head lower.

Borrowing does seem to be coming down fast than expected and debt to GDP stable – after rising sharply post-crisis it is now stabilised around 89%. UK also has a lower debt-to-GDP ratio than its rich peers. More gilts could fuel growth and lift yields, resulting in a stronger pound. At present two-year gilts yields are still hanging back below the Bank base rate with demand holding firm.

Maybe the task is not the Chancellor’s alone. The problem with persistently low rates is that it has allowed zombie companies to carry on despite being unproductive. The Bank of England has a role to play, although raising rates too quickly risks recession. For now it seems we are stuck with low productivity growth and without more borrowing it’s only really tinkering at the edges.

The best the Chancellor can do is unlock new money from the Soviet-named National Productivity Investment Fund and National Strategy Challenge Fund to spend on projects that deliver productivity gains. Roads, bridges, broadband infrastructure – there is plenty of scope for growth-positive investment.

Sterling

Cable remains in a positive uptrend for 2017 with GBPUSD now well clear of the 100-day moving average support and flirting with breaking out above the 200-day moving average. A positive reaction to the Budget could fuel further gains. Additional support is coming from the news that Theresa May has Cabinet support to increase the Brexit divorce bill to €40bn. Plenty of support for now that should help cable reassert the daily trend seen this year but a breakout above that trend is a long way off and entirely Brexit dependent.  We could easily see the pound above $1.33 tomorrow if the Budget is viewed positively although there is a sign that the rally since last Monday is losing momentum.

Equities - Housebuilders

The government has already outlined a further £10bn Help to Buy assistance. While it may increase this, the Treasury would face further criticism that it is adding to the problem of making homes unaffordable.

Therefore significant extra cash for Help to Buy may be not be forthcoming. An extension beyond the current 2021 deadline is a possibility. More demand-side help would likely lift housebuilders but at present the demand is not the issue - the problem rests on the supply side. Therefore a more meaningful uplift would come from uncorking the supply bottleneck.

The government faces competing pressures from its desire to free up planning rules to support private housebuilders, to the Nimby attitudes prevalent across those areas where the demand for new housing stock is highest. After a run of Budget climbdowns, facing a Tory backbench revolt on planning rules for the greenbelt is not what the Chancellor wants. Such a raid would be like invading Afghanistan – many have tried, but no one has come off well.

However, planning remains a bit of a distraction as housebuilders are sitting on large amounts of land they can build on. It is not in their interest to unleash a flood of new homes that crimps prices and margins.

Moreover, facing labour shortages and concerns around build quality, it is unclear whether they are in the position to exploit any loosening of planning restrictions.

If the Chancellor does decide to go for a Macmillan-style splurge on housebuilding with the public purse, it is likely that private housebuilders would in any case be required to see it through. The problem is they may not be equipped to do so.

The headline-grabbing policy tweak being talked about ahead of the Budget is about ditching Stamp Duty for any first-time buyer. FTBs make up around one third to one half of private completions for housebuilders and therefore such a move would be extremely net positive for companies. Of the largest housebuilders, Persimmon has the greatest exposure to both first time buyers and Help to Buy. On the other hand, Berkeley Group has the lowest exposure. Stamp duty reductions would also tend to support transaction activity and therefore aid estate agents like Foxtons and Countrywide.

London-focused Foxtons could stand to benefit most given that a cut to stamp duty for first time buyers would disproportionately boost buyers in the southeast where prices are highest (currently there is no stamp duty paid on the first £125,000). On the other hand, another raid on buy-to-let landlords may be considered. Mr Hammond says the 3% surcharge has had little impact on the market and may be inclined to target second-home owners and landlords again with additional charges. If following the same pattern as the original levy in April 2016, this would lead to a short-term boost to transaction volumes ahead of the deadline before acting to suppress sales and lettings.

Equities - Airlines

Low on the agenda but one that could sneak in. The Air Passenger Duty (APD) debate rears its head every time a Budget comes around and November 2017 is no different. There was widespread disappointment that the Chancellor failed to act earlier this year and again the industry is ramping up pressure.

Hitherto, the government has shown no willingness to row back on APD. However in light of Brexit and fears over the implications of a no-deal exit on the aviation sector, there may be more impetus to make UK-based airlines more competitive by bringing APD back in line with major European nations. UK APD is the highest in Europe and second-highest globally. As a guide, cutting APD in half would put the UK on a par with Germany. For internal flights the demand from the industry is to remove APD entirely to stimulate economic activity.

Airlines with strong domestic networks may be the most likely to benefit if the government acts to cut/scrap APD for internal flights. For instance Flybe says APD can account for up to half the ticket price on its cheapest routes. Politically, cutting APD on external flights and scrapping it for internal flights would be seen as a pro-growth move and one that would help ‘hard-pressed families’. A cut to APD would support airline shares by allowing carriers to lower fares without affecting margins, but it may ultimately delay some much needed consolidation in the sector by prolonging the life of some weaker firms. Without a cut to APD, higher oil prices may be about to kill off a few of the financially less secure carriers.

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