Philip Hammond Must Refrain From Playing To The Crowd

Has there ever been so much uncertainty surrounding an Autumn Statement? Phillip Hammond, while a significant player within the Conservative party for some time, has become Chancellor despite having little public profile beyond the “Westminster bubble”.

The fiscal views of the UK’s bean-counter-in-chief, moreover, remain something of an enigma. No-one seems able to say definitively if Hammond will continue with the Tories’ “austerity programme” or, in a rhetorical reversal, “loosen the purse strings” instead.

The Supreme Court’s ruling on Parliament’s right to vote on Article 50 – despite that same Parliament agreeing by a majority of six-to-one to abide by a referendum on European Union membership – adds mightily to the Chancellor’s political unknowns, as he tots up his fiscal sums.

Then there’s Europe itself – where the Italian constitutional reform, in a fortnight’s time, could upend Matteo Renzi’s precarious government. That would squeeze Italy’s already brittle bond market, reminding the world that the Eurozone’s third-largest economy, having barely grown since the single currency was launched in 1999, is still shouldering non-performing bank loans equivalent to a fifth of annual GDP. The result could be Europe-wide financial contagion.

There’s the small matter, over the coming months, of an Austrian Presidential election (last time they came within a whisker of electing a neo-Nazi) and a general election in Holland (where vehement anti-Brussels sentiment is brewing). We then face the possibility, next April, of Front Nationale leader Marine Le Pen winning the French Presidency, on a ticket to leave the EU. After that, Alternative für Deutschland will be taking on Angela Merkel’s CDU, once again on an acerbically anti-EU agenda, in Germany’s general election.

All of these populist – and increasingly popular – establishment-bashing parties represent a risk to Europe’s already fragile market stability. If any of these political renegades shows well in upcoming elections, let alone winning any kind of office, they could dismantle the status quo.

Just a few years ago, the idea that countries could leave the single currency, and that the euro might break up, was limited to the small, much-maligned pool of us who combined detailed technical knowledge of economic and monetary history with an open mind and the audacity to say what we think.

All that changed during the summer of 2010 – when the Greek debt crisis erupted and eurozone sovereign bond markets went haywire. Instantly, a “conspiracy theory” was transformed into an undeniable truth. The euro might not last forever. Eurozone bond markets, an increasingly stretched European Central Bank and the broader “European Project” have been laboring under that reality ever since.

Over the coming year, the period for which our Chancellor is supposedly setting out the fine print of his fiscal plans in Wednesday’s statement, that same truism could come to be applied to the EU. There is a multitude of upcoming political events we know about, to say nothing of those we don’t, any one of which could spark the widespread realization that the EU itself may one day disband. That realization, in turn, could unleash havoc on financial markets, in Europe and beyond.

As if that wasn’t enough “political risk”, we must then consider events the implications of which surely trump all others (so to speak) – namely those across The Pond. Will the incoming US President provoke inflation, care of his protectionist trade policies and “trillion dollar” infrastructure program? Or will he generate growth, given his determination to “make American great again” by deregulating and cutting personal and corporate taxes?

For now, while stock markets have rallied without much justification, global bond markets – which generally display far better long-term predictive acumen – are unnerved. Yields have lately risen sharply, driven by fears of “Trumpflation”.

My view is that, while Trump’s rhetoric is alarming – his “35pc tariff on imports from China” would surely result in Beijing retaliating and an incendiary trade war – his bark is probably worse than his bite. The high-tariff threats, and talk of “forcing profit repatriation on US multinationals” sound to me like stump-speech hyperbole, the opening gambits of a deal-making chancer that will end up drastically reined-in.

The same goes for his big spending plans – which could easily be curtailed by a Republican-controlled Senate and House of Representatives, packed full of fiscally hawkish GOP lawmakers who are pleased Clinton was beaten, but otherwise view Trump as an imposter and a thug.

But, in all honesty, who really knows? Has there ever been a time since the end of the Cold War when a higher and more varied degree of political risk has so threatened financial markets? And yet that is the backdrop – Brexit uncertainty, potential chaos in Europe, political pyrotechnics in the US – against which a first-time Chancellor will this weekend put the finishing touches to his Autumn Statement.

When it comes to fiscal policy, Hammond has floated the idea of “substantial” infrastructure investments and the abandonment of George Osborne’s deficit target. That, in my view, would be a mistake. Since April, during the first six months of this fiscal year, Britain has chalked-up a £46bn budget deficit. The excess of spending over receipts was £10.6bn in September alone. It’s clear that the UK, despite growing faster than expected, is once again going to miss its £67bn target for 2016/17 as a whole – and by a huge margin.

In the immediate aftermath of the 2008 financial crisis, perhaps understandably, our budget deficit exceeded £100bn – then, almost 7pc of GDP. The deficit ballooned to over £150bn in 2009 before spending another five years at £100bn or more. These are enormous sums, over seven years of triple-digit-billion deficits, more than doubling our national debt, the burden we’re dumping on our children and grandchildren.

Last year, for the first time since the sub-prime debacle, we managed to get our deficit below £80bn – still a historically large 4pc of GDP annual shortfall, but at least moving firmly in the right direction. Now, even with the economy growing strongly – in defiance of so many Remain supporters who warned of an “immediate” post-referendum recession” – our annual deficit could once again end up the wrong side of £100bn.

Sterling has been falling. While eyeing our fiscal deterioration, the markets also now looking sideways at the UK’s huge external deficit – our shortfall of exports over imports at a near-record 6pc of GDP. Against this economic backdrop, to say nothing of the political uncertainty that looms, a Chancellor would let spending rip would be playing with fire.

Hammond must also consider whether or not the Federal Reserve will raise interest rates next month, marking the definite turn of the global interest rate cycle – a trend the UK would follow relatively quickly. I’d say the US Central bank will now act, finally building on its 0.25 point move back in January. To not raise rates now, with expectations so elevated, would spread panic. To not raise now, with Trump heading for the White House, would signal that Fed boss Janet Yellen thinks the Donald is a liability.

So Fed rates will likely rise – but that’s not to say that the increase, when it comes, won’t cause serious fall-out on our grotesquely bloated, stimulus-addicted stock and bond markets. All the more reason why Hammond should hold fire on Wednesday and show some fiscal rectitude.

If he does, the Chancellor will face brickbats from the commentariat – and maybe even No.10. But that restraint, and the credibility it generates, will be repaid tenfold if the shoe drops, and a Fed rate rise results in a market backlash.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: