Investment Clock insights

The UK policy puzzle and sterling


Trevor Greetham

1 March 2016

Policy makers the world over are tabling additional stimulus to offset the deflationary impact of the slowdown in China. G20 ministers meeting at the weekend agreed to use "all policy tools – monetary, fiscal and structural – individually and collectively" to reach the group's economic goals.

Monetary policy is moving onto an easier path globally, with both the European Central Bank and Bank of Japan expected to move interest rates further into negative territory and the US Federal Reserve rowing back from initial expectations of four rate hikes in 2016. Meanwhile, we are also hearing rumblings of an easier fiscal policy stance in China, India and possibly Japan while policy is no longer contractionary in the US. Some less fiscally hawkish governments have just been elected (eg. Canada and Portugal) and there is less pressure from bond markets to reduce deficits, especially in the eurozone where the refugee crisis is also a potential source of increased government spending.

Against this backdrop it is somewhat puzzling that Chancellor George Osborne, in Shanghai for the G20 meetings, used the same 'storm clouds' gathering in the global economy to justify bigger than expected cuts to public spending towards the end of the current parliament. There is an ideological difference at work here. George Osborne has vowed to move the UK budget into surplus and he views slower growth and a drop in tax revenues as a signal to cut spending. Spending cuts themselves, however, can hurt the economy and this is the point of view taken most often by the other 19 countries in the G20.

A tight fiscal stance puts a lot of pressure on the Bank of England to support growth. It means lower interest rates than would otherwise be the case and a possible move into negative territory if the economy weakens. The Chancellor’s announcement is yet another reason for sterling weakness over and above uncertainty related to Brexit. We wouldn’t sell sterling at these levels; we don’t think the UK will vote to leave the EU in June and strength in the housing market is more supportive of rate hikes than rate cuts later in the year. On the other hand, it is hard to see sterling recovering meaningfully before the referendum vote takes place.

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