Budget in Depth

Discussion and Analysis by Charles Porter:

Today’s budget was delivered to the House of Commons with considerable showmanship and bluff. The Chancellor’s hand contained little more than off-suit low cards – 1.5 and 1.3 to be precise. However, the chancellor managed to find a concealed rabbit within the deck, admirably silencing the qualms of critics and the public alike. Hammond confronted the housing challenge confidently. Many will argue that the policies were shortsighted and do not confront the systemic problem of low housing supply and reinvestment that the UK has achieved. However, in terms of a political event for the Conservative Party and cabinet to rally behind, the Autumn budget just about managed.

The Pound fell by around 0.25% during the Chancellor’s speech, commencing shortly after 12:30, before ending up in positive territory upon its conclusion. Although perhaps sinister, the conclusion of the speech rallied the pound slightly because the opportunity or need to expound further negative news had passed.

The Chancellor presented growth forecasts that slashed GDP growth by 0.5% this year and again in 2021. With the political uncertainty that has surrounded the incumbent government only growing, this budget had to be a resounding success. The last thing the Pound needed was a major January cabinet reshuffle from a lack of ministerial confidence.

As the Chancellor has been forced to indicate over the previous months, the coffers to cover the potential fallout from Brexit were almost empty. The Chancellor’s commitment of £3bn yesterday for the next two years struck a necessary but also conservative tone. A higher fiscal insurance budget would have frightened markets both in terms of the opportunity cost foregone in inflationary-biased spending and by increasing the expectations of the cost of Brexit.

Expectations of pragmatism without scaremongering were therefore balanced adequately by the Chancellor. The vote of no confidence that would force a government defence and test of May’s leadership over the Commons and country has now reared its head twice. At least with considerable spending and popular allocation, there is something for the conservative party to rally behind. Should Hammond’s budget have placated dissenting back-benchers, her leadership will prove to be more secure.

Political security is uncommonly critical to the United Kingdom at present. The Brexit process was triggered by Article 50 of the EU’s Lisbon Treaty. This Treaty itself, as we are all too acutely aware, contains a clause limiting the secession arrangement process to two-years from declaration, in the absence of unanimous support for an extension.

The distraction of yet another general election and potential third leadership contest in little over three years, would prevent progress on the UK’s exit from the EU within this highly constrained time horizon. Moreover, should a general election occur, it is highly likely that Cabinet Secretary David Davis would be expelled from negotiations regardless of the result.

Whether or not Davis is the most qualified or well-suited to the role of the UK’s lead negotiator in Brexit negotiations is inconsequential. Davis and his EU counterpart, Michel Barnier, as well as their surrounding team members, will have inevitably come to develop a rapport, and have achieved progress and understanding. Moreover, the entire mandate of the Secretary of State would most likely be undermined and re-written, leaving the UK with probably less than a year until the all-important 29^th March 2019.

Political solidarity is therefore key to the Pound due to the high salience of satisfactory post-Brexit arrangement. It is plain to see the importance of Brexit progress to the Pound. Following the referendum and in the ensuing months, the value of the pound was eroded by around 20%. This change entirely reflected the pricing in of risk and uncertainty about what the future place of the UK amidst the EU, and the world, would be.

The announcement of under-expectation public deficit following the Spring budget could also be positive for the Pound. Primarily since the European Sovereign Debt Crisis, markets, rightly or not, have become incredibly sensitive to the value of public debt as a percentage of GDP. The fact that the conservative government managed to convince a public to elect them in purely because they would pursue a costly and painful path of austerity exemplifies how highly valued budgetary parsimony has become!

An under-forecast public deficit throughout the two quarters since the Spring budget frees up room for Hammond to facilitate inflationary spending. In turn, with only incredibly tight monetary policy on the cards, exemplified by ultra-low interest rates, the Bank of England might be free to change their forward guidance and management of market expectations.

All in all, the Pound had a good day and is likely to extent its gains over the medium term if it is not railroaded by Brexit. The volatility during the event still indicates that Brexit is the single greatest determinant of the value of the Pound. After all, news of potential December first round sufficient progress from Donald Tusk at the last EU Council meeting generated far greater upside return for the Pound. However, the easing of political tension takes at least one headwind out of the picture, for now.

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