The FTSE 100 clawed back some ground in the wake of the emergency Budget, as investors breathed a sigh of relief the VAT hike and bank levy proved to be slightly less severe than anticipated.
London's top share index was down 53 points to 5,243, after having fallen over 80 points in the run-up to the Budget, as the prospect of sharp spending cuts and tax rises prompted a flurry of profit-taking.
Despite a new banking levy and rise in VAT to 20% in January 2010, both the banking and retailing sectors rallied to session highs during the chancellor's speech.
In his speech, George Osborne said the coalition government will introduce a new levy on UK banks and foreign banks with UK operations from 1 January 2011.
The new measure will see the UK government raise as much as £2 billion annually, although the feeling in the markets is that this figure is less severe than it could be.
Joshua Raymond, market strategist at City Index, says: "The banking levy is clearly being determined by investors as less aggressive than first expected when earlier estimations were that it could be more than £3 billion."
The news sent shares across the sector 1.7% higher following a sell-off in morning trading, with the likes of Lloyds Banking Group gaining 2.7% and Royal Bank of Scotland rising 0.3%.
The retail sector also enjoyed a midday surge, prompted by the confirmation that a VAT rise would not be introduced before 4 January 2011 and will not impact most food goods.
High street stalwart Marks & Spencer became the second best performing stock on the index, rising just over 3% on the news, while supermarket Morrisons also notched up gains of 2%.
Raymond adds: "Considering the fact that the government had lowered expectations so much in the run up to today’s budget, the small market rally is hardly surprising.
"I get the feeling that a lot of investors out there are liking the directness and aggression Osborne is showing in attacking the problem.”
VAT boost for high street
There is little dispute that the hike in VAT could affect consumer spending in 2011 and the UK’s new rates have seen it fall from third lowest place in terms of competitiveness to joint 12th highest.
However, the figure comes in lower than some of the more drastic numbers touted and retailers will be relieved they have the rest of the year to adjust to the rise.
Gary Harley, head of indirect tax at KPMG, says: "Retailers will be relieved that the widely trailed VAT increase will not come in until 4 January next year, meaning that Christmas and New Year sales will be protected from it. But 2011 could be a hard year on the high street as prices go up to accommodate the new rate."
George Godber, fund manager at Matterley Asset Management, says shops will have been preparing for the rise and consumers would do well not to fear sharp price increases.
"This was largely expected and doesn’t come in until the end of the year so people have plenty of time to plan for it. It should, then, make for a bumper Christmas period of the retailers this year as people are persuaded to bring forward purchasing decisions.
"Part of the effect of VAT and its efficiency is it’s hardly noticeable on most purchases, with only the more meaningful purchases such as TVs making an impact. More importantly we had a fair budget and the retail sector is more aligned to consumer sentiment that anything else so I don’t expect any real negative moves in the retail shares, rather quite the contrary."
Housebuilders also got off lightly, as VAT will not be imposed on new houses and capital gains tax has only risen to a maximum of 28%. However, Killik & Co said some concerns remain over potential changes to planning rules.