An Autumn Statement for consumers businesses

Chancellor of the Exchequer Philip Hammond’s first detailed economic plan is aimed squarely at households and British businesses.

 

• Speculation that the Chancellor could use the Autumn Statement to launch huge spending projects now looks wide of the mark for now, after he pointed to “eye-wateringly” high public debt in comments at the weekend.
• That shifts the focus of scrutiny on to how the government aims to ensure “opportunities are shared across the country and across the income distribution”, to quote from further comments by the Chancellor.
• In turn, after another bout of jarring volatility for the pound last week, traders will welcome an inferred sterling boost if the government delays signing off widely anticipated spending for giant infrastructure projects.
• Consequent breathing space for sterling will offer respite for Britain’s factories which have borne the brunt of unfettered input price surges.

 

It is the economy’s continued resilience to perceived Brexit-related threats ahead that is expected to offer the Chancellor the fiscal “headroom” he seeks.

That economic robustness will allow the Office for Budget Responsibility (OBR) to maintain relatively benign forecasts.

 

Much of the focus for Wednesday’s statement will therefore be on updated OBR forecasts—particularly how long the OBR now expects public coffers to take before returning to a surplus.

 

Current OBR forecasts:

• GDP growth of 2%, in 2016, 2.2% in 2017 and 2.1% in 2018
• Inflation of 0.7%, 1.6% and 2%
• Unemployment of 5% in 2016 and 2017, and 5.2% in 2018
• Public sector net borrowing of 2.9% in 2016/17, 1.9% in 2017/18 and 1% in 2018/19
• Net debt as a percentage of GDP of 88.3% in 2016/17, 80.3% in 2020/21 and return to surplus in 2019/20

 

How are these forecasts likely to change?

 

Financial market and economic bounce backs have kept the economy on track for 2016.

However 2017 and 2018 forecasts now look like a stretch, taking into account sterling weakness/inflation strength and uncertainty assuming Article 50 is triggered no later than March.

One guide is the Treasury’s post-Brexit summary forecast of 1% growth in 2017, though in line with many early projections, it looks too pessimistic.

 

We see only very cautious tweaks as the likeliest outcome, perhaps projecting 2% in 2018.

 

On public finances, the OBR must revise borrowing needs and have an eye on growth, though discretionary action by the Treasury could help.

Given that latest public sector borrowing figures show the government overshooting £55bn pencilled for 2016/17, and various tax receipts are below expectations, economists have settled on a rise in borrowing of around £10bn in the current fiscal year.

 

That could lift the government’s deficit-to-GDP ratio to as high as 3.5% vs. the 2.9% March forecast.

Further out, the cost of borrowing is expected to help the spending picture. Even after the recent yield ramp, benchmark borrowing costs were 48 basis points under the OBR’s 1.9% gilt yield forecast for 2017/18, though some of that benefit may be eaten up by inflation.

All told, the government might miss an earlier five-year goal for ending the deficit by 2020/21, if market forecasts pointing to a 0.5% to GDP shortfall by then are correct.

That implies c. £70bn more borrowings each year till 2020/21 before any expansion of spending intentions are known. As noted, these are likely to be pushed back rather than not seen at all.

 

Before then, we now know that the Chancellor will hold off enhanced spending in Wednesday’s statement and aim for businesses and consumers.

 

The main themes we expect the Chancellor to target:

• Several, relatively limited infrastructure projects, with the transport sector very likely to be favoured.
• We also expect additional stimulus for housebuilding that can easily be absorbed by the total Budget announced in March of £772bn.
• Amid high profile forecasts that households will be £100 a year worse off as inflation rises, the Chancellor may offer a sop, though we think reduced VAT is unlikely for now.

 

How will the market react to the Autumn Statement?

 

In the immediate term, the market can be expected to absorb a modest deterioration in public finances such as the scenarios outlined above. However, they are of course subject to myriad unknowns that will inevitably arise after 2017.

 

The pound

Early on Tuesday, sterling briefly rose above the closely eyed level of $1.25 against the dollar, a price that has repeatedly crimped the pound’s progress ever since October’s ‘flash crash’.

However, it appeared that hints of sterling-positive contents in the Autumn Statement might not save the pound from renewed consolidation under the ‘psychological’ $1.25 level, given that the pair failed to hold above it into Europe’s trading session.

 

Stocks

The primary impact on the FTSE 100 is likely to be via the conduit of sterling, where the pound ailing against the dollar has tended to lift blue-chip investors’ spirits at the expense of sterling bulls.

We believe the likelihood that the Autumn Statement will significantly depress sterling further is low.

On that basis, we do not see another major FTSE boost from weak sterling in the medium term.

 

Gilts

Aggressive yield gaps reported at the end of last week will have gone a long way to pricing additional signals about fresh spending that might be announced in next year’s Budget.

Even so, deteriorating finances and spending could still ratchet borrowing needs to a sum equal to the government’s already inked infrastructure spend (currently about £100bn).

With Britain’s finances set to become more challenged over the next two years the market might have to get used to relatively erratic gilt yields as ‘a new normal’.