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UK Autumn Statement Underwhelms, Pound Impact May Be Limited

UK Autumn Statement Underwhelms, Pound Impact May Be Limited

2016-11-23 15:10:00
Martin Essex, MSTA, Analyst

Talking points:

  • UK Chancellor of the Exchequer Philip Hammond’s Autumn Statement will likely have only a limited impact on the British Pound
  • The independent Office for Budget Responsibility predicts lower economic growth and higher public borrowing in the wake of the UK’s Brexit decision to leave the European Union
  • But, UK interest rates are still likely to remain unchanged for a prolonged period

UK Chancellor of the Exchequer Philip Hammond presented an Autumn Statement to the Westminster Parliament on Wednesday that is unlikely to have a major impact on the future course of the British Pound, although there was a brief rise in the yields on UK government bonds, or Gilts, as the independent Office for Budget Responsibility (OBR) unveiled some bleak economic forecasts.

In his statement, which is effectively a mini Budget, Hammond announced only modest changes in the government’s tax and spending plans that are not likely to provoke a response from the Bank of England’s Monetary Policy Committee.

His statement was made against a background of an economy that is so far holding up well despite many gloomy earlier forecasts that it would be hit hard by the Brexit vote to leave the European Union. UK economic growth in the three months to September dropped by less than expected, to 0.5% quarter-on-quarter from 0.7% in the April to June quarter, according to data from the Office for National Statistics. Unemployment is at an 11-year low and retail sales growth has hit a 14-year high.

However, the OBR cut its 2017 economic growth forecast, predicting that GDP will grow by just 1.4% next year, rather than the 2.2% predicted in March. Moreover, an extra £122 billion will have to be borrowed by the 2020/21 financial year compared with the March predictions.

This suggests that the current brighter picture than many analysts were expecting following the Brexit vote could soon dim and that Hammond’s so-called fiscal “re-set” has been restrained by the poorer outlook for public-sector borrowing and the weaker economic outlook. However, the fiscal tightening planned for next year remains small, the OBR was more upbeat than some economists had expected and it was also more optimistic on growth than the consensus among economists.

Still, against this background of potentially higher borrowing in the wake of the Brexit vote, worsening public finances that rule out lavish spending or substantial tax cuts, and the likelihood that the previous target of a balanced budget by 2020 will be missed, Hammond has been left with little alternative but to proceed cautiously.

That, in turn, makes less necessary a tightening of monetary policy by the Bank of England that would likely have been prompted by a more expansionary mini-Budget along the lines of the stimulus proposed by US President-elect Donald Trump. Instead, a continuing accommodative stance by the central bank can be expected, with UK interest rates looking set to remain low for the foreseeable future and even cut further if the economy worsens.

UK government bond, or Gilt, yields are therefore likely to remain lower than the yields on US Treasuries. Ahead of the Autumn Statement, the two-year Gilt yield was 0.187% - almost a percentage point lower than the yield on the US Treasury note.

GBP/USD climbed from 1.2388 ahead of the statement but then fell back on news of a surge in US durable goods orders that lifted the US dollar all round. By mid-afternoon in Europe it was little changed from before the statement. However, the two-year Gilt yield climbed briefly above 0.2% before falling back to 0.176%.

This could continue to put downward pressure on GBP/USD, which has traded in a relatively narrow range between 1.2086 and 1.2675 over the past six weeks, although overall the statement was neutral. At 1.2392 at the time of writing, GBP/USD now faces stiff support and resistance at those two levels.

--- Written by Martin Essex MSTA, Analyst and Editor

To contact Martin, email him at martin.essex@ig.com

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