fundamental alert

U.K. Chancellor Darling Looks to Revise Fiscal Rules as the Economy Faces a Recession (Update)

Wednesday, 29 October 2008 08:03:33 GMT  |  DailyFX Research

U.K. chancellor Darling says fiscal policy must evolve. In a speech to be delivered this evening, Darling notes that it "is natural that the conduct of policy should evolve. Just as markets change, so should policy" which appear to hint at the Treasury preparing to revise their fiscal rules to allow for increased borrowing. The Treasury's 40% debt-to-GDP ceiling was already broken after taking on Northern Rock's liabilities and will be push higher still once Brandford & Bingley will be taken into the public books, together with the GBP 37 bln so far estimated to be used for bank recapitalization. Further fiscal stimulus to counteract the growth slowdown is likely require further borrowing still. The fiscal rules, which includes a policy to borrow only to invest and to keep the budget in surplus over the economic cycle, have already lost most of its creditability with the market as the Treasury has been seen as shifting the goalposts by re-classifying some borrowing or extending or shortening the length of the perceived economic cycle. There are market expectations that chancellor Darling will announce revisions or a complete abolition of the rules and that details of the new borrowing plan will be included in next month's pre-budget report.

Meanwhile, Pound-Dollar (GBPUSD) struggled to hold on to gains amid reports of good selling from macro accounts and corporate accounts on the Cable surge to 1.6219 highs ahead of the European open. Cable's retracement extended to 1.5962, marking a move in excess of 200 pips. EUR-GBP price action also followed a similar theme, basing at 0.7883 before it rallied to 0.7950. U.K. fundamentals remain soft, which has increased speculation that the BoE will deliver another 50 bp cut in November. This view has firmed up after BoE's Besley indicated late yesterday that upside inflation risk has diminished since last summer, but noted that sterling's depreciation would squeeze people's living standards. Sterling is expected to trade on the ebb and flow of risk appetite and one off order flows. Speculative names are short term buyers on the whole, while macro accounts and real money names are still looking to sell on strength. However, any sterling support would quickly give way if equity markets moved back in to negative territory.

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