Speaking early on Monday morning, the chancellor of the exchequer abandoned his claim that there would be an immediate budget in place following Friday’s leave vote, but said the country stands ready to “confront what the future holds for us from a position of strength”.
Markets were, however, less convinced. The 10-year UK government bond yield fell below 1% in early trading on Monday for the first time ever amid the political uncertainty.
“While exceptional circumstances may well require radical solutions, instant austerity through a knee-jerk ‘punishment Budget’ could have further destabilised an already febrile economy,” Tom Selby, senior analyst at AJ Bell, commented on Osborne’s stance.
“There are a series of options available to the government, but each is politically unpalatable. For example, cuts to pension tax relief or removing the state pension triple-lock would raise billions, but risk angering core Conservative voters,” said Selby, adding: “Equally, raising taxes on those in work would add insult to injury for younger generations, many of whom voted for the UK to remain in the EU.”
“However, this is likely a stay of execution rather than a full-on reprieve. If the economic warnings of the Treasury, Bank of England, OECD and others are proved correct, the next Prime Minister and his or her Chancellor will eventually need to wield the axe or raise taxes to balance the books,” said Selby.
PIMCO said it expects further action by most major central banks to limit the potential damage. “We expect the Bank of England to cut its official interest rate from 0.5% to zero relatively soon and, if more is needed, to restart quantitative easing,” said Joachim Fels, global economic advisor at PIMCO.
According to the BofA Merrill Lynch Global Research report, the UK economy will be the main victim, but as the shock for the Euro area and global economy will be significant, “policy responses will be needed beyond the ‘first-aid’ remedy market disruption normally requires.”
Osborne said that he had been in touch with European finance ministers, central bank governors, the managing director of the IMF, the US Treasury Secretary and the Speaker of Congress, and the CEOs of some of our major financial institutions during the weekend, “so that collectively we keep a close eye on developments.”
PIMCO’s Tokyo team “expects more Bank of Japan easing at the next policy meeting on 29 July and sees a high probability of currency intervention to weaken the yen in the near future,” according to Fels.
“And in the US, a July hike is now completely off the table, September is not impossible but a low probability because the dust from Brexit may not have settled yet and the US presidential race will be in full swing, and even a December hike looks increasingly questionable at this stage,” added Fels.
Osborne also explained the Treasury, The Bank of England and the FCA have spent the last few months putting together contingency plans for the immediate financial aftermath in the event of Brexit. “We and the PRA have worked systematically with each major financial institution in recent weeks to make sure they were ready to deal with the consequences of a vote to leave,” he said.
Carney’s statement that the Bank of England is ready to provide £250bn of funds through its normal facilities to continue to support banks and the smooth functioning of markets was part of that plan, noted Osbourne.
The Bank of England is now able to lend in foreign currency if needed, added Osbourne.
