Budget Day on Monday! The Prime Minister had announced an end to Austerity. The Chancellor talked of austerity coming to an end. "Not so much the end, nor the beginning of the end but the end of the beginning of the end."
Actually, it wasn't really about austerity at all. It was all about Brexit. A softening up of the back benches; a preparation for the difficult discussions ahead.
It was the beginning of profligacy of huge dimension. Blood on the spreadsheets for spreadsheet Phil. The rabbits out of the box, genies out of the bottle, leaks laid out on the despatch box. It was huge fun. £84 billion for the NHS, £15 billion for personal allowances, £5 billion for Universal Credit, £4 billion for house building, £1 billion for business rates.
Money for the High Street, Money for infrastructure, Money for Brexit, Money for potholes, Money for investment, Money for defence, yes there was even Money for public toilets. "Rate relief for those providing relief", that's a Hammond joke. A review of police budgets and money for schools, £400 million for "those little extras" like books and teachers.
Money for the regions, for the Northern Powerhouse, the Midlands Engine and Cornish Pasties. Money for the Nations, for Scotland, Wales and Northern Ireland including the DUP of course. Money everywhere. Funded by Digital Services Tax on the FAANGS like Facebook, Apple, Amazon, Netflix, Google and Satan.
Money everywhere funded by increased borrowing. In the current year, borrowing is expected to fall to less than £26 billion. That's down by £14 billion from prior year and £11 billion lower than the PBR had projected in March this year. It does make you wonder why so much attention is based on the OBR numbers at all! The forecasts aren't that great. The OBR expects GDP growth to average around 1.4% over the forecast period.
Borrowing is expected to average £20 billion in each and every year. A fiscal stimulus equivalent to equal to 1% of GDP. Based on current trends and without the spending spree, the government could have balanced the books within three years. Now the plan is to spend over £100 billion to settle nerves ahead of the Brexit move. The Chancellor explained he has a further £15 billion if needs be if things get tough. He may have to spend some of that on the Fixed Odds Betting Terminal Taper, a delay, probably not a gamble worth taking in the end …
Inflation Report ... worried about Brexit ...
Inflation report this week, the Bank is more upbeat about the economy than the OBR. Growth is expected to average 1.75% over the forecast horizon. Earnings are expected to rise above 3%. Job prospects remain buoyant, inflation is expected to remain over target but will return to the 2% level by the end of the timescale. Interest rates will rise gradually and a limited extent. Base rates are expected to rise to 1.5% at most within a three year horizon.
It's all pretty much the same stuff as usual but the Bank is concerned about Brexit. The forecasts are postulated on a mid term scenario. The range includes a smooth Brexit with continued access to the single market within the customs union. The most extreme scenario, would be a hard Brexit. No access to the single market, outside of the customs union, trading within the WTO framework. The Chequers deal, is scored about 6 plus. Canada Plus (a return to the colonies by The Governor), would mean, a job well done in Threadneedle Street, rate rise avoided during term in office.
The Inflation Report had been produced without access to or knowledge of the Autumn Budget. A profligate Chancellor boosting spending by 1% of GDP in each and every year over the next five years had not been included in any calculations. A fiscal relaxation of such dimension would lead to a higher growth forecast to over 2% in each year. An economy already experiencing supply side constraints would be subject to greater inflationary pressure than in the current outcome.
The Bank will assess the impact of the latest budget measures in the model forecasts. Expectations must surely include a revision of forward guidance on interest rates. Ten year gilt yields moved to 1.5% this week. We would expect a further rise to 2.5% within six months. Assuming a smooth Brexit, interest rates will increase much more rapidly than market expectations currently. 1.5% will be the projected level for base rates within twelve months, with a further 1% rise on the cards in 2020.
Buckle up. We are leaving Planet Zirp and will move into orbit with our North American cousins sooner than expected. Strangely, the Governor has suggested interest rates could rise in the event of a no deal scenario with the EU. What's that all about?
The Bank fears a supply side shock post Brexit, supply interruptions as a result of border disruption. More significantly a relocation of capacity out of the UK, within the customs union could occur in certain sectors. Excess demand over supply would lead to an acceleration of inflationary pressures exacerbated by softer currency. The reaction function for monetary policy would lead to a faster hike in base rates than currently expected. It wouldn't make sense, set against a scenario of rising unemployment, higher inflation and a real income squeeze.
In the case of a hard Brexit, an expansionary fiscal policy already outlined would be met by a more passive approach for monetary policy. With little or no capacity for rate cuts, interest rates would still be expected to rise gradually and to a limited extent. The Chancellor has indicated he still has some £15 billion of provisions which could be made in the event of a significant slowdown. The economy would slow, inflation would rise and the debt burden would increase ... but no need to worry, Dominic Raab is on the case …
Eye on the prize ...
Mid terms week. Trump has admitted the GOP may lose control of the House. "Well I can't be everywhere" he explained modestly.
Probably just as well. The President has forgotten the basic mantra, it's the economy stupid". Growth of 3% this year, a strong jobs market, real earnings rising, medium term problems for the economy obscured, Democrats should be out of the frame when it comes to voting.
Project Fear should have been based on the risk to recovery and jobs if Trump loses control of the House. Instead the President focused on the threat of an invasion on the Southern border of huddled masses yearning to breathe free.
"Give me your tired, your poor, Your huddled masses yearning to breathe free, The wretched refuse of your teeming shore. Send these, the homeless, tempest-tossed to me, I lift my lamp beside the golden door!"
No lamps by the Golden Door. Trump is lining up the National Guard and the Marine Corps by the Great Wall with a "Shoot to Kill" Policy if as much as a stone is lifted in anger. Separation of mother and child the back stop policy. Just as well the masses will arrive after the mid terms, the photo ops would not have been flattering.
The army projects less than 20% of the current caravan will make it to the Southern Border. With 15,000 troops in wait, that's ten soldiers for every would be arrival. No need to lock up your daughters of the South.
Trump has been surprised by the constraints of the office. He has had to learn how to deal with Congress, congressional leaders and the constitutional constraints on the executive branch. If Democrats take the House, he will be further shackled. Let's hope that will include tariffs. There are serious concerns in the Republican Party, the White House is not fully attuned to this. Surely Fox news would have provided a briefing.
The good news this week. Trump will sort out the deal with China at the G-20 meeting in Argentina. Tariffs are hurting in Trump's homeland. Unintended consequences include relocation of domestic manufactures outside of the USA. A deal with President XI is on the cards. Trump has an eye on the real prize. A Trump Tower in Beijing, Shaghai and Pyongyang ...
That's all for this week, have a great week-end, Don't Miss Our Monday Morning Update this week, we will expand further on market moves ...
The Saturday Economist
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