The trajectory of the UK economy remains uncertain, but will the upcoming Autumn Statement make its future direction any clearer?

 

The UK economy remains in danger of going into recession in the coming months with a sharp contraction in business investment likely to follow the June 23 referendum. Some of the bleaker predictions made prior to the referendum may be avoided thanks to the beneficial impact on trade of a plunge in sterling, and further monetary easing from the Bank of England. But as the bank has itself made clear, it is the government’s actions, not its own, which will matter most from now on.

The bank says maintaining strong trade ties with Europe and raising productivity will be especially important. To date, Prime Minister Theresa May’s new administration, perhaps understandably, has been coy. While the UK’s trading relationship with Europe will take a while to sort out, in the intervening period businesses are clamouring for greater clarity on other aspects of government policy.

In terms of the future direction of fiscal policy, what few signals there have been have not always been consistent with one another. All of which makes for an eagerly awaited ‘Autumn Statement’.

In this Q&A, senior UK economist Stewart Robertson assesses what Chancellor of the Exchequer Philip Hammond could potentially say in his speech to parliament on November 23.

There have been widespread calls for an end to austerity. Is this on the cards?

In a word, no. Former chancellor George Osborne had aimed to turn the budget deficit - which stands at about four per cent of gross domestic product - into a surplus by 2020. The government has abandoned the deadline for this milestone. Hammond stated in July that while the government needed to cut the deficit, it might need to “reset” fiscal policy as it also had to consider the “new circumstances” that the economy is facing.

So we could see the government moderating the pace of planned spending cuts. From a political perspective, this is perfectly sensible given that dissatisfaction with the harsh effects of austerity seemed to be partly behind the referendum result. But I don’t think we’re going to see a complete about-turn in fiscal policy.

Why do you say that?

Hammond and May have made it clear they believe the deficit is still too high. Hammond cautioned against being “cavalier” about levels of debt, while the prime minister has said there will be strict limits to any stimulus. Both have reiterated that the government is still seeking a surplus on the public finances, eventually.

Furthermore, even by the time Hammond gives his statement there will have been insufficient data post the referendum to enable him to form an accurate judgement of its impact on the economy. For instance, we’ll only have had preliminary estimates of third-quarter GDP. And while they’re likely to show a fairly swift slowdown, I don’t think that will be enough to force the chancellor into any dramatic measures, at least not yet.

So what do you make of speculation we could see a big boost in infrastructure spending?

It sounds like a great idea on paper, particularly with the government able to borrow so cheaply. I’m sceptical exceptionally low interest rates or employing more quantitative easing will have much of an impact on aggregate demand. So the Bank of England is fast running out of room to stimulate activity, meaning fiscal policy is probably now the only game in town.

However, even if the economy were to slide into recession I’m not sure we’d see the government going down this route. For a start, the experience of Japan over the last quarter of a century does not augur well for such a shift in policy. It introduced a steady stream of stimulus packages over that time, none of which have done much to jog the country out of its long, grinding stagnation.

Perhaps more importantly, infrastructure projects take a long time to get off the ground. Take the HS2 project. In January 2009, the former Labour government established a company to examine the case for a new high-speed railway linking London to various cities in northern England. And yet nearly eight years on the project seems no nearer getting off the ground amid doubts as to whether it represents value for money.

The Hinkley Point C reactor is another case in point. It was only this month given final approval, nearly nine years after the government gave the go ahead for a new generation of nuclear power stations. Electricity from the site won’t come on stream for another nine years.

Even where smaller projects are concerned, planning regulations mean there tend to be relatively long lead times between cabinet approval and the work getting underway.

Undoubtedly there are plenty of smaller projects that would have a beneficial impact on the economy’s long-term productive capacity. The government could look to initiate those, perhaps with help from the private sector. But identifying which ones will give it the biggest bang for its buck will be key.

Does that mean there’s no scope for fiscal easing?

No. It’s important to remember that any slowdown in the economy following the referendum will inevitably lead to a loosening of fiscal policy as tax revenues drop and social security spending rises. As these so-called fiscal stabilisers kick in they will put a dent in the government’s coffers, which will be only partially offset by a further sharp fall in the cost to the government of servicing its debt.

And despite my answer to the previous question, there’s still scope for an increase in infrastructure spending. Hammond has signalled as much. But he seems to favour modest, rapidly deliverable investments and has indicated they will be concentrated on improving the country’s roads and railways.

We may also see him announcing his intention to increase capital spending on schools and hospitals, while reports suggest he’ll also announce a £3bn fund to provide housebuilders with cheap loans to boost residential construction.

There is also likely to be a softening of the government’s approach to cutbacks in welfare spending, which has caused much angst, and indeed real hardship, among sections of the population

As for taxation, May’s inaugural speech as Prime Minister made it clear she wants the less well off to be the beneficiaries of any cuts. So Hammond could signal his intention to cut income tax thresholds or rates for the low paid, or VAT which taxes the poor disproportionately.

The bottom line is that we should not expect any bazookas. Given the new regime’s insistence on getting the deficit down, the chance of him announcing a fiscal stimulus package of £40bn or more, as some have suggested, seems remote at best. 

Important Information

For professional/institutional/wholesale/qualified investors only. Not to be distributed to, or relied on by retail investors.

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as 27 September 2016. This commentary is not an investment recommendation and should not be viewed as such.  They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

Aviva Investors Global Services Limited, registered in England No. 1151805.  Registered Office: St. Helen’s, 1 Undershaft, London EC3P 3DQ.  Authorised and regulated by the Financial Conduct Authority and a member of the Investment Association.  Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London EC3P 3DQ.

This article is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited and its subsidiaries Aviva Investors Securities Investment Consulting Co., Ltd. and Aviva Investors Pacific Pty Ltd (“Aviva Investors Asia”) for distribution to investment professionals only. Please note that Aviva Investors Asia does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Asia in respect of any matters arising from, or in connection with, this document.

Issued by:

Aviva Investors Asia Pte. Limited, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and is an Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1 Raffles Quay, #27-13 South Tower, Singapore 048583.

Aviva Investors Securities Investment Consulting Co., Ltd., a company incorporated under the Company Law of the Republic of China with registration number 53097616, holds a valid Securities Investment Consulting Enterprise (SICE) License to carry out Securities Investment Consulting Service and other relevant business permitted by Financial Supervisory Commission, Executive Yuan, R.O.C. and provides permitted liaison and co-ordination services only. Registered Office: Room D-1, 24F, No. 7, Section 5, Xin Yi Road, Taipei 110, Taiwan.

Aviva Investors Pacific Pty Ltd, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 50, 120 Collins Street, Melbourne VIC 3000, Australia.