Now comes the fiscal policy era
- The Bank of England £170bn stimulus package can help restore confidence
- Shinzo Abe's government recognises need to support Bank of Japan efforts
- Underpins thesis that we are shifting towards a more fiscal policy-led era
Brexit continues to reverberate as the BoE bussed in a
cool $170 bn load of stimulus package. Photo: iStock
By Neil Staines
“It was the best of times, it was the worst of times” — Charles Dickens
This time last year, things were very different for the UK. George Osborne was proudly asserting Britain as one of (if not the) the best performing major economies in the world, Mark Carney was nudging the markets towards the prospect of a rate rise, David Cameron was yet to announce the date of the EU referendum and Leicester City were 5000-1 to win the Premier League title.
Yesterday, Carney delivered his ‘Super Thursday’ press conference and along with it, the new reality. The November ‘15 Quarterly Inflation Report from the Bank of England had pointed to an enviable level of growth, from a global context, at broadly 2.5% in 2016, 2017 and 2018. Since then, successive QIR’s have brought successive downward revisions to UK growth forecasts. Yesterday saw an acceleration of that theme — the biggest growth downgrade ever in the history of the Inflation Report.
In essence, the BoE now forecasts a drop in annual growth to around 0.8% in 2017 - a fall that brings with it a heightened probability of a technical recession along the way. Furthermore, as a function of a lower GBP, the BoE also raised its expectations for inflation. This combination is likely to lead directly to an increase use of the word ‘stagflation’ in the financial and economic press.
“This is not mission difficult Mr Hunt, it’s mission impossible. Difficult should be a walk in the park” — Anthony Hopkins
In light of (and to a certain degree justified by) its weaker economic projections, the Bank of England responded with an aggressive array of easing measures, as it stated that the adjustments as a function of leaving the EU “may prove difficult”. Carney stated that the stimulus was appropriate, given the scale of the shock.
The BoE cut interest rates 25bps to 0.25% with the explicit additional statement that, should the data progress as it expects, the rate will be cut to “near zero” by year-end (though Carney was equally explicit in stating that the lower bound for interest rates is above zero and that there will be no contemplation of negative rates in the UK, let alone ‘Helicopter Money’ which Carney referred to as a “flight of fancy”)
The bank also reopened its Asset Purchase Fund, with a QE expansion of £60 billion and as much as £10 billion in corporate bond purchases. Furthermore, the Bank opened a Term Funding Scheme that acts to facilitate the transmission of monetary easing, through increasing the availability of funds for banks (and thus lending), while at the same time negating any reduction in net interest margins - thus reducing the effective lower bound to “near zero”.
“Every chemical reaction has a transition state” — Derek H. R. Barton
Here is where, if we may, we would put the UK’s monetary position in the context of global monetary policy. Carney stated clearly that “the biggest UK economic issues are structural” and that “monetary policy can only help with the adjustment”. It is “appropriate [for monetary policy] to be the first responder to a shock” but we feel that it is the turn of fiscal policy and more significantly supply side reform, to do the heavy lifting.
Carney’s £170 billion shot in the arm of the UK economy, lower interest rates and the promise to do more if required mark an important transition from our perspective, one which is taking place across the globe.
The Bank of Japan has (wittingly or not) given the market the impression that it has run out of ammunition, conviction or ideas (or all three) for ever further monetary easing, and the snap back in Japanese government bond yields (sharply higher) is a gentle reminder that the exit from such extreme monetary activism is a far from simple exercise.
From here, Shinzo Abe's government seem acutely aware that it now has an increased role to play. However, it seems that the much awaited ‘Abe fiscal stimulus’ equates to a relatively small fiscal impulse.
It's now up to the Japanese government to get things moving in Japan. Photo: iStock
Down under, the Reserve Bank of New Zealand is likely the only major central bank with credible room for conventional (or indeed otherwise) monetary policy easing (maybe even three 25bp cuts this year). Though it is arguable that the RBA is also in this camp, yesterday’s monetary policy report suggested that further easing is less likely. We would expect AUD to outperform against NZD going forward.
“Even if you fall on your face, you are still moving forward” — Victor Kiam
We wrote earlier in the week that “it is likely that we get a significant monetary easing from the Bank of England this week” and that “this likely provides a medium-term buying opportunity for GBP”. We stand by that view.
There will be many twists and turns in sentiment towards the UK economy as plans and strategy for the post-Brexit UK evolve. The Chancellor stated yesterday (in full knowledge of the measures about to be taken by the BoE) that he was “prepared to take any necessary steps to support the economy and promote confidence”. We retain our medium-term positive view on the prospects of the UK, and in line with those MPC members who dissented on the QE expansion, we would argue at this stage that recent “surveys may overstate the economy’s weakness”.
Confidence can return to the UK very quickly once a plan for Britain’s non-EU future is developed, particularly if it is framed with sweeping structural reforms. We are actively looking to re-engage in GBP over the coming days/weeks and expect renewed economic and currency outperformance over the medium term. In the Tale of Two Cities, we expect the city of London (and the rest of the UK) to outperform expectations from here. Leicester City, not so much!
— Edited by Martin O'Rourke
Neil Staines is head of trading at The ECU Group