Strategy blog: the UK goes boldly…
Strategy team: Kevin Gardiner
The Autumn Budget presented by the Chancellor confirms the UK as one of the few developed economies to be embarking on policy normalisation. The Chancellor presented a set of prospective accounts confirming that UK fiscal policy is both less loose than he'd previously suggested, and poised to normalise faster in the years ahead.
Cyclically-adjusted current borrowing is now on course to disappear in 2023/4 (previously 2025/6), having peaked at 12% of GDP in 2020/21. Headline borrowing falls from 17% in 2020/21 to 2% in 2025/26 (previously 3%). The net debt ratio is now expected to peak at 98% of GDP in 2021/22, whereas it was previously projected to peak at 110% in 2023/24 – a revision that is sensational, or should be.
The Chancellor was able to do this without actually planning any new tightening (that is, beyond what had already been announced). There is to be a further net increase in taxes, but planned spending is poised to rise by more (as part of the government's "levelling up" strategy for reducing inequality – that is, for winning the next election).
Regular readers will not be surprised at the main reason for this surfeit of cake (that is, cake for having, and cake for eating). Not for the first time, the OBR, whose economic forecasts are the input to the Treasury's projections, has been significantly too pessimistic on the rebound in economic growth, which is now put at 6.5% in 2021 (previously 4.0%). Higher inflation will probably also boost some taxes, though it will do the same to spending too (and in some unusual areas – see below).
In addition, not all of the government's contingent support for pandemic assistance may have been taken up: the starting point for debt is smaller than it was too. Again, this will not surprise regular readers.
Monetary policy – which is independent of the government of course – also seems likely to start tightening sooner than markets had expected, and earlier than in the other major economies. In his latest comments about inflation, the governor of the Bank of England has all but validated more hawkish money market expectations.
Whether he meant to speak quite as frankly as he did is moot, but for the Bank's Monetary Policy Committee not to follow through could be a risky strategy. Rates seem poised to rise (and not because of energy prices, but because the economy is stronger, and employment prospectively fuller, than the Bank had realised).
We expect the Federal Reserve to follow suit in the first half of 2022 – again, because of lasting underlying inflation pressure, not transitory headline risk.
Are these really such bold moves by the UK? As that budget arithmetic suggests, much of the fiscal "tightening" is being done by the economy, not to the economy. And a 15 basis point increase in interest rates this month – which is what the money markets think they have been promised – is much smaller than traditional monetary moves.
Nonetheless, we can see the stage being set for a rerun of economists' popular pastime of "spotting the policy mistake". At some stage in the next few months/quarters, growth indicators will doubtless surprise to the downside, at which point we should expect to read many "we told you so" essays along the lines of "central banks have killed growth again".
Such slowdowns might prove temporary, or benign (maybe by then all the pent-up demand will have been sated). If the UK – or US – economy cannot live with slightly higher nominal interest rates than today's, then our reading of it is wrong, and we're surely doomed.
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