Investment Clock insights

Sterling lacking support from latest news on UK fiscal stance


Trevor Greetham

11th October 2016

It’s been a confusing week. Last Wednesday, George Freeman, the Conservative MP who chairs the No. 10 policy board, suggested that the Chancellor would shift policy away from quantitative easing (QE) and towards fiscal spending. However, a couple of days later, Philip Hammond used an interview on the sidelines of International Monetary Fund (IMF) meetings in Washington to dampen expectations of what he called a “fiscal splurge” in his Autumn Statement on 23 November. 
Abandoning the target of a budget surplus in 2020 creates some room to ease fiscal policy in the short term, but Hammond said the framework would be used to “respond to the conditions we see in the economy” and there was no guarantee of additional investment spending in November or indeed March next year if the economy performs well.
Businesses have expressed concern that the UK looks set to leave the Single Market without transitional arrangements in place and this will impact investment decisions. Given the long lags involved, we don’t think the Chancellor should wait for the economy to weaken to ease policy. He can take advantage of extremely low gilt yields to borrow and spend on productivity enhancing projects, shifting the mix of stimulus away from QE, with its undesirable side effects on pension funds and on the distribution of income. The burden of government debt would still fall over time if nominal growth in the economy outstrips current long-term interest rates, as seems likely.
By lessening the pressure on monetary policy to ease further, a looser fiscal stance could help to support the pound at a time when political risk and capital outflows threaten a period of destabilising weakness. A weak pound is good for exports but it will increase the cost of living and squeeze real incomes. 
In the end we expect fiscal ease to come through but there could be further downside to sterling until the policy picture becomes clearer.

It’s been a confusing week. Last Wednesday, George Freeman, the Conservative MP who chairs the No. 10 policy board, suggested that the Chancellor would shift policy away from quantitative easing (QE) and towards fiscal spending. However, a couple of days later, Philip Hammond used an interview on the sidelines of International Monetary Fund (IMF) meetings in Washington to dampen expectations of what he called a “fiscal splurge” in his Autumn Statement on 23 November.

Abandoning the target of a budget surplus in 2020 creates some room to ease fiscal policy in the short term, but Hammond said the framework would be used to “respond to the conditions we see in the economy” and there was no guarantee of additional investment spending in November or indeed March next year if the economy performs well.

Businesses have expressed concern that the UK looks set to leave the Single Market without transitional arrangements in place and this will impact investment decisions. Given the long lags involved, we don’t think the Chancellor should wait for the economy to weaken to ease policy. He can take advantage of extremely low gilt yields to borrow and spend on productivity enhancing projects, shifting the mix of stimulus away from QE, with its undesirable side effects on pension funds and on the distribution of income. The burden of government debt would still fall over time if nominal growth in the economy outstrips current long-term interest rates, as seems likely.

By lessening the pressure on monetary policy to ease further, a looser fiscal stance could help to support the pound at a time when political risk and capital outflows threaten a period of destabilising weakness. A weak pound is good for exports but it will increase the cost of living and squeeze real incomes. 

In the end we expect fiscal ease to come through but there could be further downside to sterling until the policy picture becomes clearer.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.