Government throws £13bn at ‘vicious circle’ of austerity and Brexit

Industry mulls investment implications from Sajid Javid spending review

Trevor Greetham of Royal London Asset Managers.

The investment industry expects Brexit to overshadow a £13.4bn government pledge to end austerity announced in the Chancellor’s spending review on Wednesday.

Sajid Javid told the House of Commons the government would increase budgets for public services 4.1% in the 2020/21 year, the fastest rate of increase in 15 years.

The NHS will receive a £3.9bn increase while English schools will get an additional £1.8bn.

“Every single department has had its budget for day to day spending increased at least in line with inflation,” said Javid.

“That’s what I mean by the end of austerity.”

‘Huge margins of error’

In isolation, the fiscal package could add 0.1 to 0.2 percentage points to UK GDP growth, says Tilney head of multi-asset Ben Seager-Scott.

But there are caveats.

Firstly, Seager-Scott points out this was just a one-year spending review “whereas to truly end austerity and create meaningful fiscal stimulus requires a multi-year trend targeted on truly value-adding spending activity”.

“Secondly, this doesn’t get around the fact that the main obstacle to the economy is the uncertainty around Brexit, meaning any government projections are relatively meaningless given the huge margins of error.”

Austerity and Brexit in a ‘vicious circle’

The fact Brexit could hamstring the effects of fiscal stimulus comes despite the fact many people voted to leave the European Union because they were discontent with austerity, says Royal London Asset Management head of multi-asset Trevor Greetham (pictured).

Areas of the UK that suffered the largest welfare cuts under post-financial crisis austerity were most likely to vote Brexit in the 2016 referendum, according to a 2018 paper published out of the University of Warwick.

“Austerity and Brexit are in something of a vicious circle,” Greetham says. “Austerity contributed to the discontent behind the Brexit vote. In turn, all forms of Brexit are expected to damage the economy on a longer-term view, according to government impact assessments, and this reduces the long-term wherewithal to fund public spending.”

‘Better late than never’

A significant slowdown in UK growth over the last two years justifies limited fiscal easing, according to Hermes senior economist Silvia Dall’Angelo.

UK GDP contracted 0.2% in Q2 2019 putting it on a path towards 1.1% to 1.2% for the full year. That compares to 1.4% in 2018 and 1.8% in the preceding two years.

Seager-Scott describes the timing of fiscal stimulus “better late than never” stating central banks have been left to do most of the heavy lifting following the financial crisis.

But he adds: “There is not a huge amount of spare capacity in the economy at present, and there is a risk that a combination of monetary and fiscal policy stimulus into capacity-constrained economies could lead to a surge in inflation down the line, so stimulus measures will need to be carefully calibrated.”

Asset allocation implications

A fiscal boost could lift domestically orientated UK stocks, including the high street, says Gam multi-asset solutions investment director Julian Howard.

Although the political backdrop means Gam is avoiding a tactical approach to UK assets at present. “A global portfolio with an unhedged equity allocation reporting in sterling makes sense,” says Howard.

A combination of fiscal stimulus and risks of a no-deal Brexit receding could send gilt yields up, although he warns both remain huge uncertainties due to political instability. “Investors short gilts at considerable risk even at these low yields.”

Has austerity really ended?

The end of austerity would become “outright fiscal stimulus” if spending was combined with tax cuts, says Howard.

However, Dall’Angelo is not yet willing to state austerity has ended based on the limited information detailed in the spending review.

Javid failed to address the revenue side of the equation in terms of sources of funding and tax changes, she says. The lack of an Office for Budget Responsibility assessment makes evaluation of the multi-billion pound boost hard, she adds, although based on the information available she would expect an economist uplift of 0.3 percentage points.

“Given the domestic and international background, risks are skewed to the downside. However, it looks like the spending announcement has mainly an electoral motive, as the government gears up for early elections.”

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