We expect little change in UK fiscal policy in Wednesday’s budget. Instead the Chancellor George Osborne may try to nudge the Bank of England towards more aggressive monetary easing, putting further pressure on the pound.
This week, British Chancellor George Osborne will present his fourth annual budget. He will do so with the economy flatlining, deficit-reduction stalling and many commentators calling for a loosening of fiscal policy to re-start growth. Having staked his own reputation and his party’s re-election prospects on fiscal rigour, there is little doubt that the Chancellor will resist these siren calls.
But is fiscal policy really all that tight in the UK at present? Since the Chancellor’s aggressive first budget, in June 2010, the data suggest that the pace of fiscal consolidation has slowed significantly in the UK. This is reflected in a number of indicators. For instance, the cyclically-adjusted primary budget balance, a measure of government income and receipts that excludes interest payments, barely moved last year. This would normally indicate a broadly neutral fiscal stance.
It’s a similar picture with other data, such as public-sector pay. After the freeze announced in the 2010 budget, public-sector wage growth has since started to rise again and is now running at 2.0% per annum—almost double private-sector wage growth. But the most revealing statistic is probably for government spending on goods and services, which rose by 2.7% in real terms last year. This is higher than in Germany or France and in sharp contrast to the picture in the euro-area periphery. Last year, government spending on goods and services fell by 2.9% in Italy, 3.7% in Spain, 4.2% in Greece, 4.0% in Ireland and 4.4% in Portugal.
In our view, it is difficult to explain the weakness of the British economy last year on the basis of the limited fiscal tightening which appears to have taken place—however difficult conditions might seem for the general public. Nonetheless, the government is unlikely to make any major changes to policy in the budget. Instead, monetary policy is likely to continue to take the strain of demand management in the UK. Indeed, with the one eye on the 2015 election, the government may prefer to give the Bank of England a nudge towards a loosening of monetary policy.
Speculation in this area is high, but our suspicion is that the government will move cautiously at this stage—if only for fear that a more aggressive move could damage the credibility of its whole policy regime ahead of the arrival of the Bank’s new Governor, Mark Carney, in July. This means the Chancellor is unlikely to go far beyond a review of the Bank’s mandate or a formalization of flexible inflation targeting.
However, we do think that monetary policy in the UK is becoming increasingly politicized. Unless the economy breaks out of its current torpor, the whole monetary-policy framework is likely to continue moving in a more expansionary/inflationary direction. This, in turn, is likely to lead to a further weakening of the exchange rate.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Darren Williams is Senior European Economist at AllianceBernstein