Worried about the UK’s AAA credit rating, in light of its post-election fiscal crisis?
Well, here’s an optimistic view of what Dave and Nick’s new coalition can achieve.
Lombard Street Research’s Charles Dumas argues that the Liberal Conservative government will benefit from somewhat underrated ‘economic freedom of action’:
The economy ended 2009 with inventory liquidation still close to 1% of GDP, after savage cuts in earlier quarters. Inventories should move to mild accumulation during the year, contributing more than 1% of growth. Some real government spending growth is still working its way through the system, and will be replaced by modest consumer spending growth as it tails off. Devaluation of sterling has created some potential improvement in net exports, though continental weakness by the end of the year – as the German inventory snap-back fades and ClubMed recession kicks in – mean it is limited. Growth could be revised up for Q1 – partly because it usually is, partly to reflect strong March industrial production data yesterday – and could proceed for the next few quarters at about a 3% annual rate, above the 2½% trend rate.
The outgoing government’s plans involved the policy budget deficit shrinking by 2% of GDP next year. The more aggressive cuts now likely, plus some reduction in the cyclical element, should raise this to 4% off the total deficit, bringing it down to 7% of GDP. While the inventory story will cut into the business surplus, above-trend GDP recovery will boost profits, so that the business financial surplus of 10% of GDP is unlikely to come down by the same four percentage points. This tendency of the government deficit to shrink faster than the business surplus could persist beyond the 12-18 month time frame so far considered.
Economic freedom to cut would be just as well, as the FT’s Chris Giles has noted the lack of detail in the government’s ‘accelerated’ plan for reducing the deficit — while Lex has been busy raising the Greek spectre.
Interestingly, cable also seemed unsure on Wednesday, having punched past 1.49 in early trading only to fall quickly, as this chart shows:
Cable later ventured into 1.47 territory, after official data showed that the UK’s trade deficit widened again in March, beyond consensus expectations, so economic concerns aren’t to be sniffed at either.
Even so, Dumas also argues that the longer-term picture for sterling is also robust for fiscal cutting plans. As he notes:
When it comes to exchange rates, the position is balanced. The real effective rate was about 20% overvalued for ten years to 2007, and had to come down. Its 25% cut has taken it from 120% of the thirty-year average to 90%. In principle, with a relatively tough fiscal policy and therefore easier money – inflation exclusive of tax changes and energy being roughly at the 2% target and slowing gradually in response to a large negative output gap – the pound should go down. But the chief rate for trade purposes is against the euro. After a brief revival in early-to mid 2010, the prospects for the continental economy are for stagnation at best, recession more likely. The US growth may ease back at the end of the year, but offers better prospects on both the demand and supply sides, especially the latter, than Euroland. So the pound may not go down much further on a trade-weighted basis, and could remain stable or even appreciating against a crippled EMU.
But, overall…
The chief risk in the next 2-4 years is political.
Quite.
An emergency budget is due in 50 days, and a Whitehall review setting out spending cuts for the next three years will get to work in the autumn. There are other policy trip-wires in Britain’s governing shotgun marriage, too.
Plenty of freedom of action for a few upcoming coalition bun-fights too, then.
Related links:
11 reasons why Britain isn’t the next Greece – FT Alphaville
The UK is the next Greece - FT Alphaville
So, has the UK voted for a downgrade? – FT Alphaville