Board Director at Lansons
Andrew Bailey was reported to have told an online seminar for central bank governors on Sunday that “we’re operating at an unprecedented level of economic uncertainty. Of course, that is heightened now by the return of COVID…. The risks remain very heavily skewed towards the downside”.
The reference to uncertainty that is ‘heightened’ by the return of COVID makes it clear that Bailey has in mind more than just COVID – we may reasonably suppose that the lack of clarity on our trading relationships after the end of this year also looms large. The ratings agency Moody’s was less cautious in its language on Friday, identifying COVID, Brexit, a weakening of UK institutions and an apparent lack of fiscal discipline as the reason for a downgrade in the UK’s credit rating from Aa2 to Aa3 (par with countries including Belgium and the Czech Republic).
Dramatically, it decreed that “the UK effectively has no fiscal policy anchor”.
There is a danger of over-dramatising things, but sitting behind this is a real concern that the UK needs to demonstrate that it has a plan to return the public finances to sustainability – and the political ability to implement it. When Rishi Sunak unveiled his 11 March Budget, commentators were astonished by the level of spending. This has been dwarfed by what came subsequently, but with the benefit of hindsight, much of this pre-COVID spending feels like an unaffordable luxury. The Office for Budget Responsibility made clear at the time that the Chancellor’s maths was hostage to UK debt service costs remaining low – and as we flagged at our review of the Budget, COVID then rendered the figures almost instantly out of date.
The fact this happened – and the apparent absence of any real preparedness among the UK’s political class to recognise the seriousness of the situation in which the UK public finances subsequently descended – has presumably informed Moody’s judgement on UK institutions. So much cash has now been and will continue to be borrowed by the Treasury that if UK yields started rising, the public finances would quite quickly risk spiralling out of control. Moody’s actions are therefore of real concern in 1 Horse Guards Road, insofar as if they threaten to increase the Government’s repayment costs.
The Chancellor’s recent public language is worth seeing in this context. I wrote in the Telegraph last week that fiscal retrenchment is inevitable and that Sunak was now softening up political opinion for the point when, in particular, taxes go up. Moody’s is explicit in highlighting doubts that the majority of UK Parliamentarians (or public opinion) is ready for this point; Sunak is clearly trying to address this by making the case for the necessity of action. Despite this, it is highly unlikely that political opinion or the economy is prepared for spending cuts or tax rises in the short term. In other times, a Chancellor might therefore instead try to reassure the markets by doing what George Osborne did in 2010 and holding an emergency Budget which set out a plan over the medium term to bring the finances back under control. However, given the volatile situation, as illustrated by Andrew Bailey, the Chancellor has understandably concluded that he is unable to offer such a plan with any certainty.
In 2010, Osborne held a Budget which set out the pathway for the austerity that would follow. As I wrote earlier this year, Osborne used the period from the financial crisis in 2007/08 to 2010 to build a public and political consensus for tax rises and spending cuts which were then significantly implemented from 2011 onwards. In those terms, although the public finances have deteriorated much more swiftly than in 2007/08 – and the wider situation is much more uncertain – Sunak is still relatively at the outset of the crisis, much nearer 2007 than 2010. His public language is worth reading in that context, as it is clearly aimed at reassuring the markets as much as persuading his colleagues in Parliament. In saying, in his Conference Speech, that “if … we argue there is no limit on what we can spend, that we can simply borrow our way out of any hole, what is the point in us?” Sunak is therefore hoping to head off a risk that the other ratings agencies will follow Moody’s – and also to ensure that even if they do, this will not be reflected in an increase in gilt yields.
For this reason he will likely be relieved that the Bank of England is clearly set on continuing to print money – thereby helping to depress gilt yields – and also by its recent decision to consult on negative interest rates. Both will help keep the public finances sustainable – at the cost of further pain for pension funds and banks.