After the chancellors tax cuts and fiscal reforms reported last week Friday in the mini-budget, there has been much conversation, concern and speculation in the market. The British Pound reaching an all time low against the Dollar has also not helped the matter.
A report on the situation and thoughts for the future written by Fabrice Montagné and Abbas Khan from Barclays UK may help shed some light. According to the report “The chancellor surprised by delivering more tax cuts than expected, a very uncompromising view on future fiscal policies, as well as little reassurance on how the books will eventually be balanced. We expect the BoE to hike 75bp at its November meeting to mitigate medium-term inflation risks.
While the cost of the energy package (c.8% of GDP) and most of the tax cuts (1.5% of GDP) were widely expected, the chancellor nonetheless doubled down with additional tax cuts (c.0.5% of GDP), which in the absence of offsetting revenues/spending measures have raised concerns regarding UK’s fiscal strategy and policy mix.
We make three points. First, we should expect the government to make clearer its commitment to balance the books by announcing spending cuts and reform outcomes ahead of the November Budget. This should help to deflect immediate concerns relating to large unfunded tax cuts. Also, we expect the government to launch an energy saving campaign in the course of October, designed to achieve energy demand destruction. Taken together, we believe fiscal rebalancing and energy saving should contribute to contain domestic and external imbalances.
Second, even the smallest positive demand shock may lead to disproportionate inflationary consequences in the context of impaired supply conditions, tight labour markets and double digit inflation. MPC member Jonathan Haskel said that the Budget puts the BoE in a “difficult” position. We believe the mini-Budget was likely the main reason for three MPC members to vote for 75bp at the September MPC, and will be enough a reason for the MPC to deliver a 75bp hike in November (against our previous baseline of 50bp), once it has fully assessed the impact of the fiscal measures.
And three, the UK’s trade performance may be bleak and its trade balance wide, but as the UK borrows domestically and invests abroad, its external position improves when currency depreciates. And while public debt levels are large, fiscal sustainability metrics are not critically different from peers, in some cases even better. In our view, that should mitigate immediate concerns regarding risks of a Balance of Payment crisis.
All things considered, we do not think the UK’s economic fundamentals call for more hiking than our new baseline (75bp + 50bp + status quo). We also do not expect the Bank to deliver an inter-meeting hike but rather will wait for November to reset its narrative against new macroeconomic forecasts. Similarly, we do not expect the government to reverse course at this stage. Rather, as mentioned above, we expect it to pull forward by speeding up structural reforms and the spending review, in an attempt to deflect immediate market concerns.”
We keep saying that we are living in interesting times and that only time will tell, it seems that these continue to remain true.