Q1 2023 Market Update

Following a quietly positive start to the year, the news has been busy again in recent weeks as investors have endured further market volatility caused by potential problems in the banking sector. Amongst all of this, Chancellor Jeremy Hunt delivered his spring Budget, with the main headline being multiple changes to pension rules that could create significant opportunities for your financial planning. Meanwhile, inflation continues to dominate central bank policy.

In this edition, read our expert insight into these areas:

• Outlook for inflation and interest rates
• Recent events in the banking sector
• The chancellor’s spring Budget – key pension changes
• Interest rates and inflation continue to dominate central bank policy

The European Central Bank (ECB) increased interest rates by 0.5% in March, in line with what it had previously committed to, as it continues its efforts to bring down inflation. While the ECB stated that “inflation is projected to remain too high for too long”, they provided no suggestions on future interest rate hikes.

Meanwhile, in the US, the Fed raised interest rates by 0.25% – marking the ninth consecutive rate hike. While comments made during a news conference were taken to mean that the central bank may be nearing the end of its rate-hiking cycle.

Here in the UK, the Bank of England (BoE) also raised interest rates by 0.25% to 4.25%. This is due to higher-than-expected UK inflation and signs that the UK economy is holding up better than feared. The increase marks the 11th consecutive rate rise and comes after the UK saw an unexpected jump in inflation, from 10.1% in January to 10.4% in February. Most notably, food prices have accelerated at the fastest pace in 45 years.

Of course, if you are in receipt of a state pension, or an inflation-linked pension such as those in the public sector, you will no doubt welcome the 10.1% increase due in April.

Recent Events in the Banking Sector

Those with long enough memories to recall the details surrounding the collapse of Lehman Brothers, almost 15 years ago, may well have been watching the events surrounding Silicon Valley Bank (SVB), and more recently Credit Suisse, with a certain amount of trepidation. The events have certainly impacted investments and put pressure on banking stocks both in the US & Europe creating bad news for investors facing another round of market falls.

So, is this the start of another global banking crisis, and how concerned should investors be? Well, it is not really that possible to draw too many direct comparisons to the situation that banks find themselves in now and the events that happened in 2008.

Following the 2008 crisis, lessons were learned, the capital positions of banks improved, and prudential regulation was ramped-up. The 2008 crisis was caused by banks essentially gambling with risky packaged sub-prime assets and trading on valuations that were not there.

The situation that banks are in now is quite different. The pressure is being caused by rapidly rising interest rates deflating the value of the “low-risk” government bond assets that banks are holding for capital adequacy.

Whilst pressures and uncertainty do exist it should also be kept in mind that the banking sector is now subject to a rigorous amount of stress testing and the majority of banks, particularly the larger ones, are well capitalised and should be capable of weathering the current economic pressures.

Regulators and Central Banks will be monitoring the situation carefully and will likely intervene to stabilise markets where appropriate. In fact, this has already been demonstrated in the case of Credit Suisse. Following steep market falls on 15th March, the Swiss National Bank announced that it was ready to step in and help Credit Suisse if needed. This appears, at least for now, to have calmed the markets somewhat and it is now reported that this intervention may well have been enough to stop an emerging crisis from spreading.

There may well be some, albeit limited, exposure to Silicon Valley Bank in UK investment portfolios. The stock was included in some US indices, including the S&P 500. So, investors holding US tracker funds may well have had some exposure. However, in most cases, this is likely to have only represented a fraction of their overall portfolio, and with the current market volatility, the direct effect of the exposure on their overall investment values should be negligible.

Chancellor Jeremy Hunt presented a “Budget for growth”

Jeremy Hunt’s first official Budget painted a positive view of the economy. The independent Office for Budget Responsibility (OBR) stated that the economic downturn will be shorter than expected, the medium-term output is due to be higher, and the government’s budget deficit will be smaller. And so, the spring Budget focused on the government’s aims to halve inflation, reduce public debt, and boost economic growth.

With around 7 million working-aged adults classed as “economically inactive”, and more than a million people having taken early retirement, the chancellor announced increases to multiple pension allowances with the hope of encouraging some people back to work.

Pensions Annual Allowance increased

The Annual Allowance has increased from £40,000 to £60,000.

The Annual Allowance is the amount you can save into your pension each tax year (6 April to 5 April) while still being able to benefit from tax relief. In the 2023/24 tax year, this will now be £60,000.

Pensions Lifetime Allowance to be abolished

Following conversations with senior doctors in the NHS and other experienced professionals, the pensions Lifetime Allowance (LTA) has been removed, with plans to completely abolish it in a future Finance Bill.

The LTA is the maximum amount of tax-efficient pension savings you can accrue in your lifetime. This includes the total value of your pensions and comprises your contributions, your employer’s contributions from your workplace pension, tax relief, and investment returns.

From April 2023, there’ll be no limit on the amount of tax-efficient pension savings you can accrue. But there is a catch. The maximum Pension Commencement Lump Sum (PCLS) will be retained at its current level of £268,275 (25% of the current LTA of £1,073,000) and will be frozen thereafter. This means that, unless you have existing rights, it isn’t possible to amass a £2 million pension pot and take 25% as a tax-free lump sum.

Money Purchase Annual Allowance to increase

The Money Purchase Annual Allowance (MPAA) has also increased, providing a potentially useful incentive to encourage experienced people to return to work.

The MPAA limits the amount of money you can save tax-efficiently into your pension after you have started drawing flexibly from your defined contribution (DC) pension savings. The MPAA has increased from £4,000 to £10,000.

Tapered Annual Allowance to increase

The minimum Tapered Annual Allowance will increase from £4,000 to £10,000. The adjusted income threshold for the Tapered Annual Allowance will also be increased from £240,000 to £260,000.

Time will tell how much impact this will have but it certainly creates an opportunity for people to consider how they can factor these changes into their own financial plans.

So, where does all this leave UK, investors?

Whilst it is fair to say the fight against inflation is far from over, a fall in inflation is still expected as we approach the second half of the year.

The recent issues in the banking sector have certainly affected market confidence but swift intervention from central banks, as well as the lessons learned from the 2008 banking crisis, appear to have calmed markets and minimised any widespread impact.

The changes to pensions in the budget represent a real opportunity for clients to revisit their retirement planning and make the most of the tax changes introduced.

We’re here to help

As financial planners, we’ve helped clients weather many economic storms over the years, and that’s something my team and I are proud to continue doing.

Markets may rise and fall, but your investment goals should remain the same, and it’s our job to help you achieve them. For almost 20 years, clients like you have trusted us to provide honest, independent advice in a friendly and professional way.

If you have any queries about anything you’ve read in this update, please don’t hesitate to contact your financial adviser, who’ll be happy to give you all the support you need.