Osbornomics is dead. George Osborne, a previous Chancellor, advocated fiscal conservatism and monetary activism. Next year, however, might see this combination go into reverse.
In next week’s Inflation Report, the Bank of England is likely to repeat what it said in August – that a deal to leave the EU would boost demand. Back then, Governor Mark Carney said this prospect could see a rise in capital spending as companies implement investment projects they had put on ice because of fears of a no-deal departure. This, he warned, would stimulate “sharply rising excess demand” which would push inflation “well above target” and require interest rates to rise.
Since Mr Carney said that, however, Chancellor Sajid Javid has added to demand. He has announced an increase in public spending next year, which will push borrowing well above the £21.2bn currently forecast for 2020-21 by the OBR; private sector economists expect borrowing to be more than twice this, at £46.7bn.
If the government’s Brexit policy succeeds, therefore, and if the economy turns out as the Bank of England expects, then we could see a reversal of the Osborne formula next year – fiscal activism mitigated by monetary tightening.
Now, this won’t be a radical change. Mr Javid’s spending rises will only offset – if that – the fiscal tightening that is currently planned for next year because of previous decisions to freeze spending and tax credits. And Mr Carney has said that rate rises will only be “gradual and limited”. Indeed, if (as I suspect) he is overstating the tightness of the labour market and its effect upon inflation, they might eventually be very limited indeed.
Nevertheless, investors should think about the potential implications of this shift for asset prices.
One impact might be to strengthen sterling: looser fiscal and tighter monetary policy is the classic recipe for a rising currency. This is especially possible as the eurozone is unlikely to see monetary tightening for some time.
Other things being equal, this would be unwelcome for those equities with big overseas earnings, such as miners. But, of course, other things aren’t equal. One hope for these is that we could see a turnaround in the Chinese economy and hence commodity prices next year: the recent slight pick-up in monetary growth is a lead indicator of this, albeit a so-far weak one.
For domestically-oriented stocks, the new policy mix is a good thing. Equities usually benefit more from stronger economic activity than they do from low interest rates – not least because it encourages investors to take on more risk.
For gilts, though, the mix is a bad one. This is not because markets will worry about higher debt. They don’t do so. And with real interest rates negative, increased borrowing is entirely consistent with the ratio of government debt to GDP falling over time. Instead, what would raise gilt yields would be simply the expectation of higher future short-term rates.
For housing, the mix is ambiguous, with higher mortgage rates offsetting the likelihood of higher real wages (for some at least) as a result of the fiscal easing.
All this raises the question: is this already priced in? I suspect not. Futures markets are pricing in no change in short-term interest rates next year. But this, I suspect, is partly because the threat of a no-deal Brexit – which would cause rates to fall – hasn’t gone away.
If or when it does, though, this might change. Investors should therefore ask: is my portfolio ready for higher interest rates?
