The Government needs to step up its fiscal spending commitments if it wants to stabilise sterling and reduce the UK’s debt levels, according to Royal London Asset Management. The company said it hoped to see decisive action on this when Chancellor Philip Hammond delivers his Autumn Statement on November 23.
“As there is a clear headwind coming from Brexit fiscal policy has to step in to increase spending,” Trevor Greetham, head of multi-asset for Royal London Asset Management, said in a media roundtable event in London yesterday.
Sterling will be the first beneficiary out of a fiscal boost. The UK currency has fallen significantly against both the dollar and the euro, since the EU Referendum vote. It slid to record lows after the Prime Minister Theresa May confirmed the Brexit timetable. But Greetham argued that the UK part of the reason for sterling’s decline was the market perception that monetary policy is doing all the work to stimulate the economy.
“People were expecting more quantitative easing, and the market has started pricing this into their expectations. This shifted the market downwards, hence the sterling fell after Brexit,” said Hiroki Hashimoto, senior quantitative analyst at Royal London.
In the contrary, some “meaningful” government spending announcement in the Autumn Statement will help lower the currency volatility.
David Meier, economist at Julius Baer echoes Greetham’s views, saying that the Bank of England’s decision to hold the pace of another interest rate cut could offer further short term stabilisation for sterling.
Reducing UK’s Debt Level
Greetham says he is unconcerned about current debt levels in the UK, pointing out that when interest rates are low, inflation and nominal growth rates will help reduce these debt levels. This happened before when debt levels were high after the second world war, he said.
Low interest rates also allow the Government to borrow money cheaply to spend on infrastructure projects, which can help stimulate the economy, so boosting growth.
May has previously suggested she disagreed with the Bank of England’s actions of setting ultra-low interest rate, preferring instead a fiscal response to boosting the economy. However, Hammond played down the likelihood of a fiscal stimulus in response to a Brexit vote.
Despite this confusion within government circles, it is clear the market expects the announcement of a fiscal stimulus in the forthcoming Autumn Statement. A fiscal policy is needed ultimately, says Ollie Beckett, fund manager of TR European Growth trust.
Hetal Mehta, senior European economist at Legal & General agreed, saying that the economy typically gets a substantial boost from direct spending by the Government. She added that additional investment could include infrastructure projects, research and development programmes, and increased housing construction.
Greetham added that he also expected to see a VAT cut. As the value of sterling weakens, there is likely to be inflation, with the cost of imported goods costing more on the high street. A VAT cut is needed to prevent a real income squeeze by the rapid rise in imported prices.
Tanguy Le Saout, head of European fixed income for Pioneer Investment pitched in, saying that a fiscal stimulus means increased Gilt issuance, putting upward pressure on Gilt yields.
Brexit in 2017
While the shock of a Brexit vote has not been as bad as people thought, it also called into question what would happen next year, said Greetham.
“We will be watching to see if there is any fall in business investment, or intention to invest, as well a keeping an eye on consumer spending patterns,” Greetham.
