Britain’s government could make the current crash in the pound even worse in the near future if it decides to move away from the previous government’s commitments to a balanced budget and deficit reduction, towards a more expansive fiscal policy, according to analysis from Pantheon Macroeconomics.
For almost six years, the previous two governments had relied on an austerity programme, cutting spending with the stated aim of returning the UK to a budget surplus by 2020.
The new government, under prime minister Theresa May and chancellor Philip Hammond, has already scrapped that target, saying it will still look to cut the deficit, just not as quickly as George Osborne and David Cameron had proposed.
Hammond is also expected to look to stimulate the economy throughout fiscal means — in the form of borrowing, and investment in infrastructure projects like railway lines, hospitals, tech ventures, and schools — when he produces his first Autumn Statement on November 23. The new chancellor has already announced some fiscal stimulus with plans
to borrow £5 billion to fuel house building in the UK, signalling a fundamental departure from his predecessor’s policies.
The extent to which Hammond will rely on fiscal stimulus will remain unknown until the Autumn Statement, but Pantheon’s chief UK economist Samuel Tombs warns in a note to clients sent on Monday that big stimulus could be seriously bad news for sterling (emphasis ours):
“The Chancellor’s room for manoeuvre at next month’s Autumn Statement therefore has shrunk. A major “reset” of fiscal policy — resulting in higher borrowing — would lead to a corresponding increase in the current account deficit, making sterling vulnerable to bigger falls. In turn, this would push up inflation.”
Here is Pantheon’s chart:
“The large current account deficit means that sterling is vulnerable to a further deterioration in overseas investors’ desire to buy U.K. assets. The hope that exports will surge — and therefore reduce the U.K.’s external finance requirement — likely will remain unfulfilled over the next year or so.”
“All told, then, the increase in markets’ concern about a ‘hard’ Brexit has reduced policymakers’ capacity to prevent the economy slowing.”
The pound has already crashed more than 16% against the dollar so far in 2016, dropping from around $1.48 on the day Britain went to the polls in the EU referendum to less than $1.23 on Tuesday. That makes it the worst performing of any major international currency in 2016 — with the exception of the Argentinian peso.
Sterling has suffered particularly badly over the past couple of weeks after prime minister Theresa May set a firm date for triggering Article 50, which begins the official process of Britain leaving the European Union.
Things have not been helped by May’s apparent unwillingness to bend to the will of financial services in negotiations. That attitude signals that a “hard Brexit” — a complete break from Europe, and estimates suggest that such a departure would cost the UK £10 billion in lost taxes, and could cost the Treasury £66 billion per year.
As it stands, the pound does not seem to have a floor, falling substantially for four consecutive trading sessions, seemingly breaking new lows every day right now. But if chancellor Hammond increases government borrowing by deciding that fiscal stimulus is the way forward, therefore increasing the deficit and pushing the pound even lower.
There could be more pain to come.