The last few months have seen more and more bodies come out in favour of easier fiscal policy or a fiscal stimulus. For some such as the International Monetary Fund or IMF this has been something of a U-Turn as it had of course previously imposed austerity on several nations in the Euro area particularly Greece. For others it has been a policy shift from telling us that easier monetary policy would work as they decided that people would figure out that 8 years of ever easier monetary policy meant by definition that it had not. Some of course were always in favour and will be pleased to note the economic mood music joining them. There have been signs that UK economic policy was moving that way to and we have leaned some morning this morning already as UK economic announcements become subject to the political conference timetable. However some care is needed as of course the UK has run a series of fiscal deficits and the talk of a fiscal surplus was just that. I have pointed out many times that the former Chancellor George Osborne seemed to be 3/4 years away from a surplus at whatever point in time one might choose. Although there was apparently at least one person who believed them if this from Robert Peston is any guide.
@George_Osborne borrowing rules torn up & we don’t have new ones. Think what City would say if this happened on Labour’s watch
What has changed for the UK?
There has been a change of Chancellor as George Osborne was removed and replaced with Phillip Hammond and it looks as though the new government will be fiscally looser. However there was also a major change in an element of the UK public finances as bond yields or what are called Gilt yields fell heavily making it much cheaper for the UK to finance a fiscal deficit. This meant that the much vaunted “bond vigilantes” have had all the success of General Custer at Little Big Horn.
It seems like another world now to look back and see that the UK entered 2016 with a 10 year Gilt yield of around 2%. We saw international yields plunge helped by ECB and Bank of Japan policy and the song was clearly this from Alicia Keys.
I, I, I, I’m fallin’
I, I, I, I’m fallin’
Depending on which date you choose this took us to around 1.3% and then post the EU Leave vote Gilt yields fell even faster and price rose. This was a more domestic move and to some extent this time around the UK helped pull international yields lower. The Bank of England was expected to add to its existing £375 billion portfolio of UK Gilts and duly announced another £60 billion as well as Open Mouth Operations saying that more would be done if it considered it necessary. Thus the 10 year Gilt yield fell and is 0.74% as I type this as the Bank of England purchases an extra £3.51 billion of UK Gilts each week.
If we now switch to the yield which really matters for fiscal policy we see the impact of this. If we borrowed for 30 years right now as I type this the Gilt yield is 1.46%. That is extraordinarily low for the UK and as a comparison over my career ( also 30 years or so) I have seen it as high as 15%. This means that more projects should be viable due to the lower cost of financing the project.
What has the Chancellor actually said?
The Guardian has been hot in the case and reports this claimed early wire on his speech later on.
The Conservatives were elected “on a promise to restore fiscal discipline”, Hammond is to note, adding: “And that is exactly what we are going to do. But we will do it in a pragmatic way that reflects the new circumstances we face.”………“But when times change, we must change with them. So we will no longer target a surplus at the end of this parliament.”
That seems to open the door for an easing of policy which would be consistent with the hints we have had so far. Speculation is of an easing of the order of a bit more than 1% of economic output of GDP but of course that is speculation for now. We did however get one specific plan.
Hammond will also unveil a £3bn package to speed up homebuilding, including using surplus public land and brownfield sites, encouraging smaller builders and innovations such as prefabricated modular homes…….Of the £3bn total, a third will be used as short-term loan funding for smaller housebuilders and what are described as “custom builders and innovators”, intended to create an extra 25,500 homes before 2020.
An extra 25,500 homes does not sound much does it? Also there is something very familiar at play here for announcements about extra UK housing which is that some of it has been announced in the past! So only around a third is actually new here. Perhaps we should be grateful that announcements of more have in reality meant less as has happened at the Ebbsfleet project.
They should get in the person I watched for a while on Saturday evening dismantling one of the cranes by Battersea Power Station! Quite a work ethic and very brave too.
The BBC has gone further.
“As we go into a period where inevitably there will be more uncertainty in the economy, we need the space to be able to support the economy through that period,” he said. “If we don’t do something, if we don’t intervene to counteract that effect, in time it would have an impact on jobs and growth.”
As ever it is the two i’s of infrastructure and investment which lead the rhetoric.
“I do think there is a case that we should look at very carefully for targeted, high-value investment in our economic infrastructure”
There is a fair bit to consider here. The fiscal policy of the UK is on its way to a reset and is doing so from a position of an existing deficit as shown below. From the Office for National Statistics.
In the financial year ending March 2016 (April 2015 to March 2016), the public sector borrowed £76.5 billion. This was £18.9 billion lower than in the previous financial year and less than half of that in the financial year ending March 2010 (both in terms of £ billion and percentage of GDP).
So austerity was a reduction in the overall deficit over time rather than a real push to a surplus. In the meantime circumstances have changed because the UK can borrow at around 1.5% for the longer-term rather than the 5% or so expected back in the day by the Office for Budget Responsibility.
Can we rise to the challenge or will it be another example of what is called “pork-barrel” spending? I am sure you can all think of examples of both. If we just look at travel infrastructure there are clear cases yet sadly we seem ever more wedded to the expensive HS2 project which will not actually carry that many people. As Battersea Power Station is on my mind perhaps Pink Floyd could have another go but this time replacing the pink elephant with a white one. An HS3 style plan for northern cities seems much wiser to me. Although of course there are capital style risks for the future in letting the national debt rise and rise as well as dangers for inflation with money supply growth also strong as I pointed out on Thursday..
Meanwhile UK manufacturing appears to be doing rather well if this morning’s Markit PMI survey is any guide but of course that is so far…..
There are regular reports that we can borrow at negative levels via index-linked Gilts which may lead some to conclude that this is the way to go. However some of this is another Ivory Tower misunderstanding. Yes there are elements that look cheap here but unlike conventional Gilts there is a variable which needs to be assumed which is inflation and in particular inflation as defined by the Retail Price Index. An inflationary episode would lead our new experts to be declaring yet another “surprise” which of course “could not possibly have been expected”