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Our views 09 May 2022

JP’s Journal: Windfalls and whether to tax them

5 min read

Time for a windfall tax on unearned gains? Yes, according to a lot of the media, with reports highlighting the bumper profits of BP and Shell. The fact that BP made a loss due to the write down of its Russian asset was not widely reported.

Also, less widely publicised, is the 40% tax already paid by North Sea producers, double the UK corporation tax rate. I know the profit and cashflow figures are massive and it may not seem right during a cost-of-living crisis to see the oil giants being ‘cash machines’. But windfall taxes seldom deliver the quantum of money that people think. Even on the suggestions of an additional 10% levy we are talking about another £1-1.5bn. This is big money when looked at from a personal perspective – but less so for a trillion-plus economy. Setting rules and sticking to them is good policy – it creates certainty and confidence. I do appreciate, however, that politicians find it difficult to stick to rules.

Actually, if we want to focus on the real unearned gains, should we look at the UK housing market? If we go back 25 years, the BP share price was about 370p; today it is 427p. If that 370p had matched the performance of UK housing shareholders in BP would be able to sell their shares above £16. Of course, investors have received dividends from BP, but houseowners have ‘received’ imputed rent. The rise in UK house prices has had nothing to do with skilful investment, it has just accrued through the collapse in real yields and the pernicious impact of quantitative easing (QE) (ignore the protestations from the Bank of England (BoE) – this policy went on too long). A windfall tax on UK housing – now that is the real money generator. I wonder whether that will fly with the electorate? Or the government, which is prepared to tax the act of working to protect the inheritances of the middle class.

Central banks

Last week markets were pretty volatile. The US Federal Reserve (Fed) delivered its expected 50bps rate hike. Initially equity and bond markets took comfort from the downplaying of more significant hikes (75bps) going forward. This lasted 24 hours before markets refocused on the likely path of rates: eight more increases of 50bps over the next year. Yields on 10-year US treasuries rose above 3% and the NASDAQ fell 4%; in the US 3% seems to be the new 2%. The Fed’s balance sheet run-off will start soon (a short $50bn), with double that from September. This contrasts with the dithering in the UK.

The BoE delivered its rate hike on cue – taking bank rate from 0.75% to 1%. Three members voted for a 50bps increase but the main focus was on the new growth and inflation projections. The BoE now forecasts that the UK will enter recession next year, seeing a contraction of 0.25%. Now, this is based upon market interest rate projections and the BoE think that these are too high. Using market rates, the BoE sees Consumer Price Index (CPI) inflation well below 2% on its three-year horizon.

The BoE remains downbeat about the UK economy, seeing the unemployment rate rising in 2023. This is based upon high inflation (CPI at 10% in Q4 2022) eating into household real disposable income, slowing consumer spending, and hitting real economic activity. So why hike at all? The answer is mainly around credibility although the fig leaf of higher pay settlements was wheeled out.

On active quantitative tightening (QT) for government bonds, the BoE effectively put off the decision until Q3. I really don’t understand the reluctance to pull the QT trigger, preferring to tighten monetary policy via rates. This much more directly impacts the consumer, the very group they are worried about. It should be said that the BoE is not the only body cutting its growth forecast. In the latest World Economic Outlook, the International Monetary Fund (IMF) reduced its 2023 global growth rate by 0.2%, with the UK seeing the biggest cut amongst the G7. At 1.2% for UK growth in 2023 it still looks ‘healthy’ relative to the BoE’s forecast.

Currencies and credit

Sterling continued its retreat last week: a double-edged sword as it increases input costs but makes exports cheaper. On balance, however, the weakness in the currency just adds to the inflation pressures we are seeing.

Credit markets were not happy. Sterling investment grade spreads made new 2022 highs, showing a widening of 2bps. In truth it felt worse than that with ‘bid’ levels back from expectations while new issue premiums remained elevated. Financial bonds continued to be a weak feature with the more defensive areas continuing to outperform. High yield markets followed a similar path with my preferred measure of credit spread closing at 5%, compared with 3.7% at the beginning of year.

The recent weakness in equity markets can be put down to three interconnected factors. Discount rates (real yields) continue to move up, making future cashflows less valuable. This is particularly relevant for growth sectors such as technology. Second, most major central banks, bar Japan, are looking to tighten policy to tackle inflation. Third, earnings projections are coming down as the growth outlook deteriorates and cost pressures increase. On the face of it not encouraging for credit either. However, at 1.35% I believe that the sterling investment grade spread already reflects bad news and I continue to prefer credit to government bonds.


Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.